If the Mexican peso's forward rate premium is 4 percent with IRP, what will happen to...

If the Mexican peso's forward rate premium is 4 percent with IRP, what will happen to the forward premium if the United States lowers rates? Explain.

Expert Solution

If the Mexican peso is having a forward rate premium, it will mean that the Dollar will be trading at a forward discount and if the United States has lowered the rates, then it will be leading to increasing the forward rate premium of Mexican pesos, because when the interest rate is lowered in the economy, it will be having a negative impact on the exchange rate and the dollar will be depreciating due to lowering of the interest rate and when the dollar will be depreciating it will mean that the forward rate premium which was already existent in the market will get widened because the dollar has depreciated more.

Hence the forward rate premium will be increasing, if the United States dollar has lowered interest rate because this premium is on Mexican pesos.

jeff jeffy answered 2 years ago

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