Chapter 3, Problem 1BIC

Mexican interest rates are normally substantially higher than U.S. interest rates. What does this imply about the forward rate as a forecast of the future spot rate? Does the forward rate reflect a forecast of appreciation or depreciation of the Mexican peso? Explain how the degree of the expected change implied by the forward rate forecast is tied to the interest rate differential. Do you think that today’s forward rate or today’s spot rate of the peso provides a better forecast of the future spot rate of the peso?

The cash rate in Australia is a benchmark interest rate which is set by the Board of the Reserve Bank ofAustralia and has recently been at a record low.(a) If the cash rate were to increase, would you expect the Australian dollar to increase or decreaseagainst most other currencies? Explain your answer. (b) If the cash rate were to decrease, would you expect the Australian dollar to increase or decreaseagainst most other currencies? Explain your answer. (c) Explain why the cash rate is not expected to increase until 2024 at the earliest?

Imagine an American MNC. Why it might decide to borrow in a country such as Brazil, where interest rates are high, rather than a country like Germany, where interest rates are low? Discuss why this may be the best strategy for the firm, given your understanding of the relationship between inflation, interest rates, and exchange rate.