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purchasing power parity is to predict future spot rate using inflation rate while interest rate parity is to predict forward rate using interest rate.
is future spot rate same with forward rate?both use to predict future rate? can we use interest rate parity to estimate future spot rate or use purchsing power parity to estimate forward rate?
when we have to predict rate in the future, can we use either one of them to get the same answer?
In theory, using either interest rates or inflation rates to predict future spot rate should give the same result.
In practice they do not, and inflation is regarded as giving a better prediction of the future spot rate.
Yes!!
It is extremely unlikely that they will be the same!
Although in the exam we can forecast the future spot rate using the relative inflation rates, in real life inflation is only one factor affecting it – we have no idea at all what the actual spot rate will be in the future.
However, forward rates quoted by the bank are not the banks prediction – they base them solely on relative interest rates (the reason being that the bank itself is using money market hedging on the money – they as a result cannot lose out!)
For a fuller explanation of this you should really watch my lectures on foreign exchange risk management.
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