Question

If the spot rate for the Swiss Franc is that 0.95 SF is equal to 1 US $, and the annual interest rate on fixed rate one-year deposits of SF is 0.15% and for US$ is 2.4%, what is the eight-month forward rate for one dollar in terms of SFs? Assuming the same interest rates, what is the 18- month forward rate for one SF in US$s? Is this an indirect or a direct rate? If the forward rate is an accurate predictor of exchange rates, in this case will the SF get stronger or weaker against the dollar? What does this indicate about the market’s inflation expectations for Switzerland as compared to the United States economy?

Answer 1

e). Inflation is closely related to interest rates, which can influence exchange rates. Countries attempt to balance interest rates and inflation. Low interest rates in Switzerland spur consumer spending and economic growth, and generally positive influences on currency value. If consumer spending increases to the point where demand exceeds supply, inflation may ensue, which is not necessarily a bad outcome. But low interest rates do not commonly attract foreign investment, whereas higher interest rates in US tend to attract foreign investment, which is likely to increase the demand for a country's currency.The ultimate determination of the value and exchange rate of a nation's currency is the perceived desirability of holding that nation's currency. That perception is influenced by a host of economic factors, such as the stability of a nation's government and economy.