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Analytical Application - Coursework Example

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Answer 1. The forward exchange rate of any currency can be determined using the interest rate parity theory formula which is as follows Fr = 1 + Ro Sr 1 + Rd Where Fr is the theoretical parity forward rate which is being determined Sr is the current spot rate Ro is the prevailing interest rate of the overseas country; and Rd is the prevailing interest rate of the domestic country…

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Analytical Application

Country Annual inflation rate Spot rate USA 3% N/A UK 4.2% 1.62 Substituting the values in the purchasing power parity formula Forward rate = ( 1 + 0.042 ) x 1.62 1 + 0.030 Forward rate = 1.639 Answer 2 The appreciation / (Depreciation) in the British pound using the interest rate parity theory is as follows Country Spot rate One year forward rate Appreciation / (Depreciation) Percentage UK 1.62 1.633 0.013 0.80% The appreciation / (Depreciation) in the British pound using the purchasing power parity theory is as follows Country Spot rate One year forward rate Appreciation / (Depreciation) Percentage UK 1.62 1.639 0.019 1.17% Answer 3 The forecasted forward rate using both interest rate parity theory and the purchasing power parity theory appears to be an unbiased estimate of the future spot rate of the currency. ...
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