Problem 4, pg 78. bk 2 Schweser Spot rate NZD/US = 1.4286 Forward rate NZD/US = 1.3889 The question in the book: 1) Are interest rates higher in the US or New Zealand? My first thought was that rates must be higher in New Zealand, which would be the cause of why their their currency was appreciating vs. the USD. But this is the wrong answer so my logic is flawed. Can someone spell out the proper logic to solving this problem? I’m thinking it may involve using the Interest Rate parity equation forward/spot = 1+D/1+F. Thanks!
We are expecting the to depreciate, since the forward rate is lower. Therefore according to Interest Rate Parity, the US Interest Rate must currently be higher than the NZD Rate, leading to a depreciation of the vs NZD. (Remember if the US Int rate is higher than NZD, we expect the $ to depreciate.)
I think it is fine to use the equation. In this case, assuming that you take the US to be “domestic”, then this will be quoted in FC/DC. So it will be (1+F)/(1+D). Since Forward/Spot in FC/DC is less than 1, it is clear that the foreign rate is less than the domestic rate (i.e. rates in US> rates in NZ). It is either domestic over foreign for everything, or foreign over domestic for everything.