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Finding Forward and Spot Rates in International Economics

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1. Implication of IRP. Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the U.S. is 7%, while the one-year nominal interest rate in Australia is 11%. The spot rate of the Australian dollar is $.60. You will need 10 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many U.S. dollars will you need in one year to fulfill your forward contract?

2. Implication of PPP. Today's spot rate of the Mexican peso is $.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7%, while the Mexican inflation over this year is expected to be 3%. Wake Forest Co. plans to import from Mexico and will need 20 million Mexican pesos in one year. Determine the expected amount of dollars to be paid by the Wake Forest Co. for the pesos in one year.

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Solution Summary

There are two problems. Solution to first problem describes the steps to find out forward rate based on Interest Rate Parity. Solution to second problem explains the steps to find out spot rate based upon Purchasing power parity.

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1.Implication of IRP. Assume that interest rate parity exists. You expect that the one-year nominal interest rate in the U.S. is 7%, while the one-year nominal interest rate in Australia is 11%. The spot rate of the Australian dollar is $.60. You will need 10 million Australian dollars in one year. Today, you purchase a one-year forward contract in Australian dollars. How many ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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