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Hi John, regarding Question 2 (c) the answer states that “the swap fixed future exchange rate altho Casasophia will lose out if inflation rate is lower than 9.7% Since future spot rates will depreciate by less than what is predicted by the forward rate. “
Isn’t the forward rate based on the interest rates (ie mazabia govt base rate and casasophia govt base rate)?
Why would inflation rate being lower than 9.7% affect the forward rate which is based on these interest rates?
Thank you for your time.
Although it is interest rates that determine forward rates, in theory interest rates and inflation rates go up and down together. So lower inflation will (in theory) result in lower interest rates.