Question

Your managing director has received forecasts of US$ exchange rates in two years^-time from three leading banks. $/£ forecasts 31 December 2022

Pallbank	1.25
Superbank	1.55
Emubank	1.68

The current spot mid-rate (December 2020) is $1.5240/£

A non-executive director of your company has suggested that in order to forecast future exchange rates, the interest rate differential between countries should be used. She states that as short term interest rates are currently 6% in UK, and 8.5% in the USA, the exchange rate in two years time will be $1-597/£.

Required:

You have been asked by your managing director to prepare a brief report discussing

1.The likely validity of the non-executive director's estimate

2.Possible reasons for the wide spread of forecasts by the banks.

Answer 1

Solution:

Current Spot rate =  $1.5240/£

The interest rate in the US = 8.5%

The interest rate in the UK = 6%

The likely validity of the non-executive director's estimate:

The calculation by the non-executive director is not proper as the calculated exchange rate is $1.1656/£ but she has calculated the value as $1.597/£.

Possible reasons for the wide spread of forecasts by the banks.

Pallbank	1.25
Superbank	1.55
Emubank	1.68

• The difference between the banks is because of the estimates of the interest rate by banks.
• Macroeconomic factors that will cause the  exchange rate to vary