ABSTRACT
Exhibit 88 displays that under a freely floating exchange rate system, future spot exchange rates are theoretically determined by differing national rates of inflation, interest rates, and the forward premium or discount on each currency. Parity conditions are for any percentage change, or difference in rates. Hypothetical data used in the exhibit are as follows:
1. Currency rates: a. Spot Rate (
indirect
) S
= ¥104/$ b. Forward Rate (one year) F = ¥100/$ c. Expected Spot Rate S
= ¥100/$ d. Expected change in S:
e. Forward premium on yen: 2. Expected rate of inflation:
a. Japan 2% b. United States 6% c. Difference 4%
3. Interest on 1-year Government Security a. Japan 1%
b. United States 5% c. Deference 4%
100----------------------- = 4%
See also FISHER EFFECT; FORWARD RATES AS UNBIASED PREDICTORS OF FUTURE SPOT RATES; INTEREST RATE PARITY; INTERNATIONAL FISHER EFFECT; PURCHASING POWER PARITY.
