Question

Spot exchange rate
USD/BRL	3.7633
USD/GHS	5.1300
USD/RUB	65.840

Country	1-year interest rate	Inflation rate
Brazil		3.80%
Ghana	16.0%	9.00%
Russia	7.75%
United States	2.50%	1.90 %

Part 5. Parity conditions

1a. Forecast the expected exchange rate in one year for the Russian ruble.

b. What parity condition does this rely on?

2a. Forecast the expected exchange rate in six months for the Brazilian real.

b. What parity condition does this rely on?

3a. What is the expected nine month forward rate for the Ghanaian cedi?

b. What parity condition does this reflect?

Answer 1

1. a. and b

As per interest rate parity (IRP) the difference in relative interest rates in two countries will be reflected in change in their exchange rates.

As per IRP Expected exchange rate = Spot exchange rate*((1+domestic interest rate)/ (1+international interest rate))^time

1 year USD/RUB = 65.84*((1+0.0775)/(1+0.0250))^1 = 69.2123

2. a. and b

As per Purchasing Power Parity (PPP) the difference in relative inflation rates in two countries will be reflected in change in their exchange rates. The country with higher inflation rate will have a depreciation in its currency value and vice-versa.

As per PPP Expected exchange rate = Spot exchange rate*((1+domestic inflation rate)/ (1+international inflation rate))^time

6 months USD/BRL =3.7633*(((1+0.038)/(1+0.019))^(0.5)) = 3.7982

3. a and b

As per international fisher effect (IFE) the exchange rate differential between two currencies is determined by nominal interest rate differential.

where, (1+Nominal interest rate) = ((1+real interest rate)*(1+inflation rate))

As per IFE Expected exchange rate = Spot exchange rate*((1+domestic nominal interest rate)/ (1+international nominal interest rate))^time

Nominal interest rate in Ghana = ((1+16%)*(1+9%))-1 = 26.44%

Nominal interest rate in US = ((1+2.50%)*(1+1.90%))-1 = 4.4475%

9-month forward rate for USD/GHS = 5.13*(((1+26.44%)/(1+4.4475%))^(9/12)) = 5.9205

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