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Question 9.ST.5: Assume that Mexican interest rates are much higher than U.S....

Assume that Mexican interest rates are much higher than U.S. interest rates. Also assume that interest rate parity (discussed in Chapter 7) exists. If you use the forward rate of the Mexican peso to forecast the Mexican peso’s future spot rate, would you expect the peso to appreciate or depreciate? Explain.

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The peso would be expected to depreciate because the forward rate of the peso would exhibit a discount (be less than the spot rate). Thus, the forecast derived from the forward rate is less than the spot rate, which implies anticipated depreciation of the peso.

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