Question

Small Corp. would like to forecast the value of the Turkish lira five years from now using forward rates. Unfortunately, Small is unable to obtain quotes for five-year forward contracts. However, Small observes that the five-year interest rate in the United States is 11 percent, while the Turkish five-year interest rate is 15 percent. Based on this information, the Turkish lira should ____ by ____ percent over the next five years.

Answer 1

The 5-year U.S. interest rate = 11%

The 5-year Turkish interest rate = 15%

The country with a higher interest rate should experience a depreciation in their currency over a long period of time. So, the Turkish Lira should depreciate.

The change in exchange rate = (1 + interest rate in the U.S.)/(1 + interest rate in Turky) - 1

The change in exchange rate = (1 + 0.11)/(1 + 0.15) - 1

The change in exchange rate = -0.0347826087

The amount of depreciation in Lira = 3.47826087%

The Turkish lira should depreciate by 3.47826087 percent over the next five years.