Deriving Forecasts from Forward Rates
Response to the following problem:
Assume that interest rate parity exists. Today the 1-year U.S. interest rate is equal to 8 percent, while Mexico's 1-year interest rate is equal to 10 percent. Today the 2-year annualized U.S. interest rate is equal to 11 percent, while the 2-year annualized Mexican interest rate is equal to 11 percent. West Virginia Co. uses the forward rate to predict the future spot rate. Based on forward rates for 1 year ahead and 2 years ahead, will the peso appreciate or depreciate from the end of year 1 until the end of year 2?