To determine the future exchange rate, when do you multiple the spot rate by the interest rate differentials, and when do you multiply it by inflation differentials? Some of the exchange rate currencies readings show these situations: D/F * (1 + D interest rate)/(1 + F interest rate) = Future exchange rate While in the international asset pricing chapters, Ive seen something similar to D/F * (1 + D inflation)/(1 + F inflation) = Future exchange rate So, when is interest rate used, and when is inflation rate used? any clarification would be appreciated
Doesn’t the one give you the FORWARD exchange rate (i.e. using the interest rate differentials) and the other give you the EXPECTED exchange rate (i.e. using the inflation differentials)…
Both calculations will yiled future spot prices. Determining which calculation you use (i.e. interest rate differentials or inflation rate differentials) will be based on the question asked. If you are asked to calculate the forward spot price based on interest rate parity, then you will have to use interest rate differentials (Fwd premium or discount) and; If you are asked to calculate the forward spot price based on purchasing power parity, then you will have to use inflation rate differentials. Econ goes over the calculation for both.
Thank you so much.