- CFA Exams
- CFA Exam: Level I 2021
- Study Session 5. Economics (2)
- Reading 18. Currency Exchange Rates
- Subject 4. Forward Calculations

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**CFA Practice Question**

The Mexican economy is predicted to average double-digit inflation of 22% per annum over the next two years. The forecast for the U.S. is 2.5% per annum. If the current exchange rate is $0.1177/peso, what will be the exchange rate two years from now?

B. $0.0989

C. $0.1401

A. $0.0831

B. $0.0989

C. $0.1401

Correct Answer: A

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**User Contributed Comments**
13

User |
Comment |
---|---|

Aimy |
Forward rate=0.1177*square(1+2.5%)/square(1+22%)=0.0831 |

chenyx |
why not:Forward rate=0.1177*square1.025*square1.22 |

Ali1 |
because the formula is: 1 + rd / 1 + rf = Forward / spot so it follows: forward = spot * ( 1 + rd / 1 + rf) |

tenny45 |
Why do you need to square them? |

gord |
You square because the question is based on a two-year time period. |

mtcfa |
Isn't this a PPP prblem rather than an interest rate parity problem? Therefore the formula should be S1/S0 = (1+If)/(1+Id), which is discussed in a later section. |

aggabad |
mtcfa is right: S1 = S0*(1+Id)square/(1+If)square = 0.1177*(1.025)square/(1.22)square = 0.0831 |

achu |
Answer is A. Two year period is a bit of a mean twist but it's good to be ready... |

Rotigga |
DC = USD EAR[Mexico] = (1.22)^2 ? 1 = 0.4884 EAR[US] = (1.025)^2 ? 1 = 0.050625 (1.050625) / (1.4884) = Forward / $0.1177; Forward = $0.0831 (Correct!) |

charomano |
I agree with mtcfa. However, the question could be understood as: what is the expected spot rate and not what should be the forward rate. Expected spot rates are exposed to inflation and interest rates. But if we need to fix a forward now, we must consider interest rates. In efficient markets, expected sport rates should be the forward rates booked now. |

Raycoyuen |
Why is US being the domestic and Pesco being foreign.. so depressing.. don't understand at all |

vivianyip |
don't understand |

MathLoser |
Please don't try to guess domestic and foreign things. If the question stated: $0.1177/peso. That means USD/MXN = 0.1177 USD = price currency MXN = base currency. forward / spot = (1+ Interest rate price currency) / (1+Interest rate base currency) |