Question

Suppose that the interest rate on dollar accounts is equal to 2% (i_$ = 0.02), the interest rate on Polish zloty accounts is equal to 4.5% (i_zł = 0.045), and the expected exchange rate between the dollar and the zloty one year from now is e^e = 4 zł/$. Assume that the (uncovered) interest parity holds.

Find the spot exchange rate, e. (Answer in zł/$ and round to the nearest tenth.)

Answer 1

Solution:

Given data is,

The interest rate on dollar is equal to 2%

The interest rate on Polish zloty accounts is equal to 4.5%

Now we calculate the spot exchange rate:

The interest rate parity equation is

Forward exchange rate = Spot exchange rate (1+m) (1+r) a

Using the above equation,

the spot exchange rate can be obtained.

4zł/$ = Spot exchange rate (1 +0.02) 7

Solving for the spot exchange rate

Spot exchange rate = 4.1 zł/$

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