The current exchange rates between Australian dollars and US dollars is AUD 1 = USD 0.7500.Interest rates for one year are 5 per cent in Australia and 8 per cent in the US.What is the expected spot exchange rate?

Question

Quizplus · Accepted Answer

To find the expected spot exchange rate, we can use the interest rate parity formula:

Forward exchange rate = Spot exchange rate x (1 + home interest rate) / (1 + foreign interest rate)

Using the given exchange rate and interest rates, we get:

Forward exchange rate = 0.75 x (1 + 0.05) / (1 + 0.08) = 0.7703

This suggests that the expected spot exchange rate should be higher than the current spot exchange rate of 0.7500. Only option D offers a possible range for the expected spot exchange rate, with AUD 1 = USD 0.7700 being the closest to our calculated value. However, USD 1 = AUD 1.3000 is the reciprocal of the same exchange rate and is also correct. Therefore, the best choice is D.

The Current Exchange Rates Between Australian Dollars and US Dollars