Question

Assume that the spot exchange rate of the Singapore dollar is $0.70. The one year interest rate is 3 percent in the United States and 7 percent in Singapore. What will the spot rate be in one year according to the IFE? What is the force that causes the spot rate to change according to the IFE?

Answer 1

According to International Fisher's Effect, the expected change in the exchange rate of two currencies is approximately equal to the difference between their countries' nominal interest rates. Based on assumption that, Countries with higher nominal interest rates experience higher rates of inflation, which will result in currency depreciation against other currencies.

Interest Rate in Singapore = 7%

Interest Rate in US = 3%

Difference in Nominal interest = 4%

Hence, it is expected that Spot rate of Singapore will depreciate against US by 4%. Due to higher nominal interest.

Spot Rate after one year = 0.7*(1 - 0.04) = 0.672