Question

James Smith, an international fund manager, uses the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. James gathers the financial information as follows:

Current rand spot exchange rate $0.188

Expected annual U.S. inflation 8%

Expected annual South African inflation 6%

Expected U.S. one-year interest rate 1%

Expected South African one-year interest rate 0.08%

Calculate the following exchange rates (ZAR and USD refer to the South African rand and U.S. dollar, respectively).
a. Using the IFE, the expected ZAR spot rate in USD one year from now. (2 point)
b. Using PPP, the expected ZAR spot rate in USD one year from now. (2 point)

C. Using IRP (interest rate parity), the one year ZAR forward rate in USD. (2 point)

Answer already in CHEGG is incorrect.

Answer 1

a)

The International Fischer rate the expected exchange rate is given as

Given the US interest rate, 1% and SA interest rate is 0.08%

Then the expected spot rate in one year is

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b)

Using PPP the expected exchange rate is given as

Given S1=$0.188 and the US inflation rate is 8% and the South African inflation is 6%

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c)

According to IRP the expected spot rate is given as