An Asset Manager Has Conducted an Extensive Econometric Study and Proposes

question 4

Essay

An asset manager has conducted an extensive econometric study and proposes a forecasting model. He has found that a currency with a high interest rate tends to appreciate relative to a currency with
a low interest rate. The simple forecasting model for the one-year exchange rate is that a currency should appreciate over the year by the amount of the interest rate differential quoted today. For example, if the Australian dollar exchange rate is AUD/$ = 2 and the one-year interest rates in AUD and $ are 4% and 7%, respectively, the U.S dollar should move up by 3% relative to the Australian dollar, and your forecast for the exchange rate at the end of the year is AUD/$ = 2.06.
a. What is the current forward exchange rate?
b. What type of forward transaction would you conduct to capitalize on your forecast?
c. If everyone were using your model and following your strategy, what would happen to the exchange and interest rates?

---

Definitions:

Printed Documentation

Physical documents that have been printed on paper, serving as references or records.

Partitioning Technique

A method used in computing and mathematics to divide data sets or problems into smaller, more manageable parts.

Extended Definition

An explanation that goes beyond a simple dictionary definition by providing additional context, examples, and details.

Set of Instructions

comprises detailed, step-by-step information on how to complete a task or operate something.