Question

Assume that interest rate parity holds. The U.S. five‑year interest rate is 5% annualized, and the Mexican five‑year interest rate is 8% annualized. Today’s spot rate of the Mexican peso is $.20. What is the approximate five‑year forecast of the peso’s spot rate if the five‑year forward rate is used as a forecast?

Answer 1

Using equation

F=P(1+i)^n

n=5

using u.s forecast i=0.05

p=$0.2

F=0.2(1+0.05)^5

F=$0.255

Using mexican forecast,we will have

i=0.08

F=$0.2938

Taking average approximate forecast=0.2938+0.255/2=$0.2744