Question

In: Finance

The spot exchange rate for the Thai bhat is 30.000 bhat to the dollar or .00333...

The spot exchange rate for the Thai bhat is 30.000 bhat to the dollar or .00333 dollar to the bhat. For capital budgeting purposes, Ramo Corp needs to estimate the exchange rate 5 years from now. The U.S. interest rate is 2%; the interest rate in Thailand is 6%. Calculate The estimated 5 year forward rate between the 2 currencies.

Please show all works and steps

Solutions

Expert Solution

Solution:

As per the Interest rate Parity model

Exchange rate differential = Interest rate differential

( Forward Rate / Spot Rate ) = [ ( 1 + Interest Rate in Home Currency ) / ( 1 + Interest Rate in Foreign Currency ) ] n

Where n = No. of years

As per the Information given in the question we have

U.S. Interest rate = 2 % = 0.02

Thailand Interest rate = 6 % = 0.06

Spot rate of the Dollar is = 30 Thai Bhat

Thus Thai Bhat / $ = 30 Thai Bhat

Applying the above values in the formula / Equation we have

Forward Rate / 30 = [ ( 1 + 0.06 ) / ( 1 + 0.02 ) ] 5

Forward Rate = [ 1.06 / 1.02 ] 5 * 30

Forward Rate = [ 1.0392 ] 5 * 30

Forward Rate = 1.2121 * 30

Forward Rate = 36.3622 Thai Bhat

Forward Rate = 36.36 Thai Bhat ( when rounded off to two decimal places )

Thus the dollar's estimated exchange rate in a 5 years = Forward Rate = 36.36 Thai Bhat

Note : ( 1.0392 ) 5 is calculated using the excel formula =POWER(Number,Power) = POWER(1.0392,5) = 1.2121


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