Can anyone help me out with this question from a past paper on IFE? I can't figure out how to actually use the formula:
(S1/S0) = (1+ih)/(1+if) for a single period
ih = interest rate in home currency
if = interest rate in foreign currency
S0 = spot exchange rate at the beginning of the period
St = spot exchange rate at the end of the period
And the question is:
Suppose that in Japan the nominal interest rate is 8% and inflation is expected to be 3%. Meanwhile, the expected inflation rate in the Eurozone is 12%, and the nominal British interest rate is 12%. Assume that the current exchange rate is 0.94 £/€.
What is your best estimate of the exchange rate at which the pound will be selling relative to the Euro in one year's time?
Thanks so much!!
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