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Chapter 8

Q. 8.ST.5

Assume that the Australian dollar’s spot rate is $.90 and that the Australian and U.S. one-year interest rates are initially 6 percent. Then assume that the Australian one-year interest rate increases by 5 percentage points, while the U.S. one-year interest rate remains unchanged. Using this information and the international Fisher effect (IFE) theory, forecast the spot rate for one year ahead.

Step-by-Step

Verified Solution

e_{f}=\frac{1+i_{b}}{1+i_{f}}-1 =\frac{1+.06}{1+.11}-1

\cong -.045 , or -4.5%

S_{t+1}=S(1+e_{f})

= $.90 [ 1 + ( -.045 ) ]
= $.8595