Question

If US T-bill rate is currently at 5% and that of Mexico is 8%, what will be the exchange rate five years from now if the spot exchange rate is $0.20 per peso? Tip Use the "Amoateng Gut-Check" to forecast A. $0.2303 B. $0.2103 C. $0.1737 OD. SO 1567 E none

Answer 1

Ans: A. $0.2303

Explanatory Solution:

Given:

US T-Bill Interest Rate = 5 %

Mexico Interest Rate = 8 %

Current Spot Exchange Rate = $0.20 per peso

Time Period = 5 Years

To Calculate:

The Exchange Rate (the forward exchange rate) 5 years from now if the spot exchange rate is $0.20 per peso.

Process: Calculations:

Formula:

“Amoateng Gut-Check” for Interest Rate Parity to forecast “The Forward Exchange Rate” is given by:

“E(St=n) = S0 × [(1+ rForeign) / (1+ rDomestic)] ^n”

Where:

E(St=n) = The Forward Exchange Rate Forecast

S0 = Current Spot Exchange Rate

n= Number of Forecast Period (In Days, Weeks, Months and Years)

rForeign = Foreign Interest Rate

rDomestic = Domestic Interest Rate

Here:

S0 = $0.20 per peso

n= 5 years

rForeign = 8 % (Mexico Interest Rate)

rDomestic = 5 % (US Interest Rate)

On putting these values in the formula, we get,

E(St=n) = 0.20 × [ (1 + 8%) / (1 + 5%)] ^5

E(St=n) = 0.20 × [ (1 + 0.08) / (1 + 0.05)] ^5

E(St=n) = 0.20 × (1.08 / 1.05) ^5

E(St=n) = 0.20 × (1.0285714286) ^5

E(St=n) = 0.20 × 1.1512569955

E(St=n) = 0.2302513991 ≈ 0.2303

The Forward Exchange Rate Forecast, E(St=n) = $0.2303

The Exchange Rate 5 years from now if the spot exchange rate is $0.20 per peso will be $0.2303.

So, our answer option is A. $0.2303

Ans: A. $0.2303