Forecasting Based on PPP versus the Forward Rate
Response to the following problem:
You believe that the Singapore dollar's exchange rate movements are mostly attributed to purchasing power parity. Today, the nominal annual interest rate in Singapore is 18 percent. The nominal annual interest rate in the United States is 3 percent. You expect that annual inflation will be about 4 percent in Singapore and 1 percent in the United States. Assume that interest rate parity holds. Today the spot rate of the Singapore dollar is $.63. Do you think the 1-year forward rate would underestimate, overestimate, or be an unbiased estimate of the future spot rate in 1 year? Explain