Assume that interest rate parity holds. The U.S. five-year interest rate is 5% annualized, and the Mexican five-year interest rate is 8% annualized. Today's spot rate of the Mexican peso is $.20. What is the approximate five-year forecast of the peso's spot rate if the five-year forward rate is used as a forecast?
A) $.131.
B) $.226.
C) $.262.
D) $.140.
E) $.174.

Question

Quizplus · Accepted Answer

SOLUTION:
$( 1.05 ) ^ { 5 } / ( 1.08 ) ^ { 5 } - 1 = - 13 \% ; \$ .20 [ 1 + ( - 13 \% ) ] = \$ .174$

Assume That Interest Rate Parity Holds