CFA Practice Question

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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?

A. $0.0831
B. $0.0989
C. $0.1401
Correct Answer: A

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)
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