The spot rate of the New Zealand dollar is $0.68. The spot rate of the Argentine

Question

The spot rate of the New Zealand dollar is $0.68. The spot rate of the Argentine Peso is 0.084 New Zealand dollars. You expect that the one-year inflation rate is 8 percent in the New Zealand, 10 percent in Argentine, and 3 percent in the U.S. The one-year interest rate is 9% in New Zealand, 8% in Argentine, and 2% in the U.S. Assume that locational arbitrage and triangular arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in the International Fisher Effect. What is your expected spot rate of the Argentine Peso in one year with respect to the U.S. dollar?

Explanation / Answer

US New Zealand Argentina Peso

Spot Rate $0.68 0.084 New Zealand Dollar = 0.084*0.68 = $0.05712

Inflation Rate 3% 8% 10%

Interest Rate 2% 9% 8%

Note: We have assumed that interest rate mentioned in question is nominal interest rate.

As per International Fischer Effect, Expected Spot Rate of Argentine Peso in one year is:

Current Spot Rate * (1 + Interest Rate (Argentina)) / (1+Interest Rate (US))

$0.05712 * (1+8%) / (1+2%)

$0.05712 * (1.08) / (1.02) = $0.05712 * 1.059 = $0.06048

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