Forecast Errors from Forward Rates
Response to the following problem:
Assume that interest rate parity exists. One year ago, the spot rate of the euro was $1.40 and the spot rate of the Japanese yen was $.01. At that time, the 1-year interest rate of the euro and Japanese yen was 3 percent and the 1-year U.S. interest rate was 7 percent. One year ago, you used the 1-year forward rate of the euro to derive a forecast of the future spot rate of the euro and the yen 1 year ahead. Today, the spot rate of the euro is $1.39, while the spot rate of the yen is $.009. Which currency did you forecast more accurately?