In: Finance
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
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