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- April 15, 2021 at 1:42 am #617679
Handria is a country that has pero for its currency & Wengry is a country that has dollar for its currency.

The current spot rate exchange rate is 1.5134 peso = $1

Using interest-rate differentials, the one year forward exchange rate is 1.5346 peso = $1

The currency market between peso & the dollar is assumed perfect & international fisher effect holds.

Which of the following 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 forward exchange rate

I don’t know how to answer this question sir. I have cancel the two options C & D since they are not true BUT confused with the options given such as A & B. Can you pls clear this problem to me?

April 15, 2021 at 9:54 am #617711Using the IRP formula, for the forward rate to be higher, the actual/nominal interest rate in Handria (the peso country) will be higher than that for Wengry (the $ country). Therefore B is correct.

In theory, interest rates go up and down with inflation rates, and therefore if the interest rate in Handria is higher, then so too the inflation rate should also be higher. Therefore A is not correct.

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