From the news, you identified a trend that Mexican nominal interest rates have been substantially higher than U.S. nominal interest rates in recent years.
1. According to Fish Effect, what do you expect inflation gap between two country’s inflation rate?
2. What does this imply about the future changes to Mexican peso vs. USD exchange rate and why? (explain with parities you have learned)
3. What does this mean to your business when you need to covert peso profit periodically into USD dollars? Should you hedge your peso denominate profits?
4. Assume three months later, the annual interest rate is 10% in Mexico and 1.5% in the US, the spot rate is $0.05 per peso and the one year forward rate is $0.048 per peso. Is interest rate parity holds? If not, can your company take advantage of this arbitrage opportunity? How much is your profit if you have $1million?
5. Since Mexican nominal interest rate is often substantially higher than U.S. interest rate. What is the future spot rate of peso vs. USD when you use peso/USD forward rate to forecast future spot rate? Based on which parity do you make your prediction here?
6. What would you expect the range of interest rate differentials between peso & USD affects the degree of expect changes on peso vs. USD exchange rate?
7. What other forecast methods you can use to forecast peso exchange rate in the future? Please explain each forecast method’s advantages and disadvantages respectively?