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Assume that interest rate parity holds. The U.S. five‑year interest rate is 0.07 annualized, and the...

Assume that interest rate parity holds. The U.S. five‑year interest rate is 0.07 annualized, and the Mexican five‑year interest rate is 0.03 annualized. Today’s spot rate of the Mexican peso is $0.30. What is the approximate 10‑year forecast of the peso’s spot rate if the 10‑year forward rate is used as a forecast?

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Answer #1

The approximate 10 year forecast of peso's spot rate can be computed as:

Interest rate parity is given as:

(1+interest rate in domestic country)/(1+interest rate in foreign country)=Forward rate/spot rate

Forward rate=$0.30((1+0.07)10/(1+0.03)10)

Forward rate=$0.4391

Thus approximate 10 year forecast of peso's spot rate is , forward rate=$0.4391

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