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Problem 4
If the $: Yen spot rate is $ 1 = Yen 110 and interest rates in Tokyo and New York are 3
and 4.5 percent respectively, what is the expected dollar yen exchange rate one year
hence?
Solution 4:
According to interest rate parity, the future exchange rate is expressed by
1 + tD
CT = CO -----------
1 + tE
1 + 0.03
= 110 X -------------
1 + 0.045
= 108.42 or $ 1 = Yen 108.42
As US interest rates are relatively higher, dollar has undergone depreciation with respect
to yen.
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Problem 5
The US inflation rate is expected to average about 4 percent annually, while the Indian
rate of inflation is expected to average about 12 percent annually. If the current spot rate
for the rupee is $ 0.0285, what is the expected spot rate in two years?
Solution 5
According to purchasing power parity theory, the expected spot rate for the rupee in one
year would be
$ 0.0285 X (1.04/1.12)
Similarly, the spot rate for the rupee in two years is going to be
$ 0.0285 X (1.04/1.12) X 1.04/1.12)
= $ 0.0285 X (1.04/1.12) 2 = $ 0.0245