Hi everybody,
Here is the question:
The home currency of ACB 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:
Home country:
Spot rate 20.00 Dinar per $
Interest rate 3% per year
Inflation rate 2% per year
Foreign country:
Interest rate 7% per year
Inflation rate 5% per year
What is the six-month forward exchange rate?
A 20.39 Dinar per $
B 20.30 Dinar per $
C 20.59 Dinar per $
D 20.78 Dinar per $
The actual right answer is A using interest rate parity theory.
My question is how to know whether I should use interest rate parity theory or purchase power parity theory with such a few information ?? With the latter the result is B...
because for obvious reasons, both of them give different answers...
Thank you in advance