2021 Book 4 Curriculum p183, paragraph above Example 5. It writes: “Given a choice of assets, currency exposure decisions should be based on projected appreciation or depreciation relative to forward FX rates rather than on the basis of projected spot FX appreciation/depreciation alone.”
How is projected spot FX different from Forward rate, as I thought the are the same thing.
Any insight will be appreciated, thanks in advance.!!
The forward rate is not necessarily an unbiased estimator of the future spot price.
This is easier to see in equity forward contracts: do you really think that the price of, say, TSLA will increase at exactly the risk-free rate?
Flashback of Covered IRP and Uncovered IRP.
CIP uses forward rate while UIP uses expected spot rate. Expected spot rate is theoretical, cannot be bought; while forward rate is an actual contract. I guess in an ideal world forward rate will be unbiased and = expected spot rate?
The point of interest rate parity is not to predict the future spot rate accurately. The point is to prevent arbitrage.