Omni Advisors, an international pension fund manager, uses the concepts of pur- chasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. Omni gathers the financial information as follows:
|
Base Price level
|
100
|
|
Current U.S. price level
|
105
|
|
Current South African price level
|
111
|
|
Base rand spot exchange rate
|
$0.18
|
|
Current rand spot exchange rate
|
$0.16
|
|
Expected annual U.S. inflation
|
7%
|
|
Expected annual South African inflation
|
5%
|
|
Expected U.S. one-year interest rate
|
10%
|
|
Expected South Africa one-year interest
|
8%
|
Calculate the following exchange rates (ZAR and USD refer to the South African rand and U.S. dollar, respectively):
a. The current ZAR spot rate in USD that would have been forecast by PPP.
b. Using the IFE, the expected ZAR spot rate in USD one year from now.
c. Using PPP, the expected ZAR spot rate in USD four years from now.