Shoesmith Wave Inc. a new and largely unproven economic forecasting service, exp

Question

Shoesmith Wave Inc. a new and largely unproven economic forecasting service, expects the inflation rate in South Korea to average 9 percent per year over the next 5 years. In comparison, Shoesmith expects a U.S. inflation rate over this same period to be 3 per- cent per year. The yield on 5-year U.S. government bonds is 6 percent per year. The yield on 5-year Korean government bonds is 11 percent per year. One percentage point of this yield differential can be accounted for by political risk differences between the United States and South Korea, with the United States perceived as having the lower political risk. The current exchange rate is 350 won per dollar.

Forecast the future 5-year spot rate for the won (versus the dollar) using the Shoesmith Wave forecast and the forecast from the financial markets.

Explanation / Answer

The country whos yield is higher than other country the exchange rate is expected to depretiate forward So korean won interest rate is higher than US so it will depretiate in future Spot rate is 350 5 year forward rate Yield on korean bond 11% Yield on US bond 6% 5 year spot rate for WON 366.509434

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