# Econ Question

The spot rate on the New Zealand dollar (NZD) is 1.4286 NZD/USD, and the 180-day forward rate is 1.3889 NZD/USD. This difference means: A. interest rates must be lower in the U.S. than in New Zealand. B. interest rates must be higher in the U.S. than in New Zealand. C. the NZD is expected to depreciate. D. the dollar is expected to appreciate. Not necessarily hard, but I’m curious what other people put.

B…

Since it will take less NZD to buy the same USD, the NZD is expected to appreciate (it will be worth more). The flip side is that the USD is expected to depreciate. According to Fisher, the country with the higher interest rates will see its currency depreciate (higher interest rates mean inflation ; inflation means that your currency will buy less stuff = your currency will be worth less). So, we said that the USD is expected to depreciate. Hence, the correct answer is: B. interest rates must be higher in the U.S. than in New Zealand.

Yeah B is correct. I guess I was looking at it like since the dollar was obviously depreciating, interest rates had to be lower and there would be less demand for the dollar. With less demand the dollar depreciates. Where am I flawed in my logic? Edit: I get your point about inflation, but doesn’t demand come in somewhere?

Fisher states that real interest rates have to be the same everywhere (integrated markets); and that the difference in nominal rates can only be due to differences in inflation rate. Where am I flawed in my logic? You think about it from the standpoint of what you see in the news everyday (possibly short term effects). The CFAI curriculum looks at it from a theorical economics standpoint and has a longer term perspective.

Ah interesting. Thanks for the explanation. Much appreciated.

According to IRP: Domestic interest rate= (Forward/Spot)* Foreign interest rate if F/S<1 then Foreign IR > Domestic IR

prossetti Wrote: ------------------------------------------------------- > Yeah B is correct. I guess I was looking at it > like since the dollar was obviously depreciating, > interest rates had to be lower and there would be > less demand for the dollar. With less demand the > dollar depreciates. Where am I flawed in my > logic? > > Edit: I get your point about inflation, but > doesn’t demand come in somewhere? Forward rates are set absolutely by the Interest Rate Parity = it’s an abitrage relation. Supply/demand/inflation are irrelevant for forward rates. Don’t mix up forward rates (what I can buy NOW for delivery later) and future spot rates (what I will be able to buy in the future for immediate delivery).

so the idea that higher interest rates relative to another country increases foreign investment, which increases demand and thus increases exchange rate only applies to the spot rate? was just going to ask this ? and saw the thread…

This should be ‘B’