21. Handria is a country that has the peso for its currency and Wengry is a country that has the dollar ($) for its currency.
The current spot exchange rate is 1.5134 pesos = $1.
Using interest-rate differentials, the one-year forward exchange rate is 1.5346 pesos = $1.
The currency market between the peso and the dollar is assumed perfect and the International Fisher Effect holds.
Which of the following statements is true?
A.
Wengry has a higher forecast rate of inflation than Handria
B.
Handria has a higher nominal rate of interest than Wengry
C.
Handria has a higher real rate of interest than Wengry
D.
The forecast future spot rate of exchange will differ from the forward exchange rate. the answer given is b can u please explain y its not a? If the forward rate is higher than the spot rate, then Wengry has the higher interest rate. If Wengry has the higher interest rate, then according to the IFE, Wengry also has the higher inflation. right?
N
Navami·
21. Handria is a country that has the peso for its currency and Wengry is a country that has the dollar ($) for its currency.
The current spot exchange rate is 1.5134 pesos = $1.
Using interest-rate differentials, the one-year forward exchange rate is 1.5346 pesos = $1.
The currency market between the peso and the dollar is assumed perfect and the International Fisher Effect holds.
Which of the following statements is true?
A.
Wengry has a higher forecast rate of inflation than Handria
B.
Handria has a higher nominal rate of interest than Wengry
C.
Handria has a higher real rate of interest than Wengry
D.
The forecast future spot rate of exchange will differ from the forward exchange rate. the answer given is b can u please explain y its not a? If the forward rate is higher than the spot rate, then Wengry(Dollar) has the higher interest rate. If Wengry has the higher interest rate, then according to the IFE, Wengry also has the higher inflation. right?
M
mrjonbainModerator·
Spot exchange rate 1.5134 pesos to $1
Forward exchange rate 1.5346 pesos to the dollar.
This indicates a depreciation of the pesos is expected.
It indicates a higher nominal interest rate in Handria.
H
harryamoatey·
using example one, it is quoted as E/$ (EUR/USD)where the first currency is the base and the second is the quoted currency.
Why is it not aligned to real life.
J
John MoffatTutor·
It is real life. Different countries / bodies quote the exchange rate in different ways.
J
John MoffatTutor·
Market efficient is in Chapter 2 of our free lecture notes and the lecture that goes with the chapter.
Business valuation are in Chapters 15 and 16 (and the lectures that go with them).
The lectures are indexed in chapter order - the order in which they are intended to be watched.
S
shikhap1·
Hi John. Thank you so much for making this concept so simple and precise. It was to the point and saved a lot of my time. :)
J
John MoffatTutor·
Thank you for your comment :-)
J
joakie·
Hi John, Thank you for your wonderful lectures, could you please help me by telling where can i find the videos for Fishers effect and Interest rate parity :)
J
John MoffatTutor·
Although they are summarised in Chapter 22 of the free lecture notes, they are covered in different lectures.
The Fisher effect is relevant when calculating the nominal cost of capital and is explain in the lectures on investment appraisal with inflation.
Interest rate parity is relevant for calculating forward exchange rates and is explained in the lectures on foreign exchange risk management.
V
Vishesh·
Hey John,
I was confused about a Question i came across in the specimen Exam on the ACCA website. In your lecture you have said always use the purchasing power rate but in their answer they have applied the interest rate parity formula. Hence what is to be done when both rates are mentioned? (this is question-1 of the specimen exam)
The home currency of Acaba Co is the dollar ($) and it trades with a company in a foreign country whose home currency is the Dinar. The following information is available:
Spot rate
20.00 Dinar per $
Interest rate
3% per year Home country
7% per year Foreign country
Inflation rate
2% per year Home country
5% per year Foreign country
What is the six-month forward exchange rate?
20.39 Dinar per $
20.30 Dinar per $
20.59 Dinar per $
20.78 Dinar per $
Answer- 20 x (1·035/1·015) = 20·39 Dinar per $
J
John MoffatTutor·
I do not say to always use the purchasing power parity formula at all!
We use purchasing power parity when forecasting a future spot rate, but we always use the interest rate parity formula when calculating forward rates (as is asked for in this question). This is all explained in my lectures on managing foreign exchange risk.
V
Vishesh·
Oh, I'm sorry. Thank you for clearing my confusion and the quick reply :)
J
John MoffatTutor·
You are welcome :-)
N
Nika·
In lecture notes there are The fisher effect and interest rate parity.
Where are can find videos regarding them?
N
Nika·
found it
J
John MoffatTutor·
Good :-)
S
soheb20092·
which lecture is the video, care to share?
K
karts2010·
where is the lecture notes for fishers effect and interest rate parity
J
John MoffatTutor·
Chapter 22 of our free lecture notes and the free lectures that go with them.
T
tasmeya·
In Interest Rate Parity, why does country having lower interest rate become stronger and higher interest rate become weaker?
J
John MoffatTutor·
Interest rate parity is not used to forecast spot rate - it is used to determine forward rates, and why this is the case is explained in my free lectures on forward rate and on money market hedging.
A
Anusha·
In example 2, how do we say that yen is stronger and pound is weaker?
The current spot exchange rate is 1.5134 pesos = $1.
Using interest-rate differentials, the one-year forward exchange rate is 1.5346 pesos = $1.
The currency market between the peso and the dollar is assumed perfect and the International Fisher Effect holds.
Which of the following statements is true?
A.
Wengry has a higher forecast rate of inflation than Handria
B.
Handria has a higher nominal rate of interest than Wengry
C.
Handria has a higher real rate of interest than Wengry
D.
The forecast future spot rate of exchange will differ from the forward exchange rate. the answer given is b can u please explain y its not a? If the forward rate is higher than the spot rate, then Wengry has the higher interest rate. If Wengry has the higher interest rate, then according to the IFE, Wengry also has the higher inflation. right?
The current spot exchange rate is 1.5134 pesos = $1.
Using interest-rate differentials, the one-year forward exchange rate is 1.5346 pesos = $1.
The currency market between the peso and the dollar is assumed perfect and the International Fisher Effect holds.
Which of the following statements is true?
A.
Wengry has a higher forecast rate of inflation than Handria
B.
Handria has a higher nominal rate of interest than Wengry
C.
Handria has a higher real rate of interest than Wengry
D.
The forecast future spot rate of exchange will differ from the forward exchange rate. the answer given is b can u please explain y its not a? If the forward rate is higher than the spot rate, then Wengry(Dollar) has the higher interest rate. If Wengry has the higher interest rate, then according to the IFE, Wengry also has the higher inflation. right?
Forward exchange rate 1.5346 pesos to the dollar.
This indicates a depreciation of the pesos is expected.
It indicates a higher nominal interest rate in Handria.
Why is it not aligned to real life.
Business valuation are in Chapters 15 and 16 (and the lectures that go with them).
The lectures are indexed in chapter order - the order in which they are intended to be watched.
The Fisher effect is relevant when calculating the nominal cost of capital and is explain in the lectures on investment appraisal with inflation.
Interest rate parity is relevant for calculating forward exchange rates and is explained in the lectures on foreign exchange risk management.
I was confused about a Question i came across in the specimen Exam on the ACCA website. In your lecture you have said always use the purchasing power rate but in their answer they have applied the interest rate parity formula. Hence what is to be done when both rates are mentioned? (this is question-1 of the specimen exam)
The home currency of Acaba Co is the dollar ($) and it trades with a company in a foreign country whose home currency is the Dinar. The following information is available:
Spot rate
20.00 Dinar per $
Interest rate
3% per year Home country
7% per year Foreign country
Inflation rate
2% per year Home country
5% per year Foreign country
What is the six-month forward exchange rate?
20.39 Dinar per $
20.30 Dinar per $
20.59 Dinar per $
20.78 Dinar per $
Answer- 20 x (1·035/1·015) = 20·39 Dinar per $
We use purchasing power parity when forecasting a future spot rate, but we always use the interest rate parity formula when calculating forward rates (as is asked for in this question). This is all explained in my lectures on managing foreign exchange risk.
Where are can find videos regarding them?