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Prediction of exchange rate

As of November 1, 1999, the exchange rate among the Brazilian real & U.S. dollar is R$1.95/$. The consensus estimate for the U.S. & Brazil inflation rates for the next 1-year period is 2.6% & 20.0%, respectively. How would you predict the exchange rate to be at around November 1, 2000?

Since the inflation rate is quite high in Brazil, we may use the purchasing power parity to forecast the exchange rate.

                              E(e)        = E(∏$) - E(∏R$)

                                             = 2.6% - 20.0%

                                             = -17.4%

                              E(ST)       = So(1 + E(e))

                                             = (R$1.95/$) (1 + 0.174)

                                             = R$2.29/$

 

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