Assume that the 1-year interest rate for a 1 year loan in the U.S. is 15%, while
ID: 2722214 • Letter: A
Question
Assume that the 1-year interest rate for a 1 year loan in the U.S. is 15%, while the 1-year interest rate on a 1-year loan in Australian dollars (AUD) is 9%. Further, assume that you are given the following probability distribution for future spot FX rates in AUD:
Possible % change in the spot FX rate ($/AUD) Probability of occurence
-1% 30%
3% 20%
5% 50%
What is your best estimate of the expected (% change) in the value of the AUD over the coming year?
a.2.8% appreciation
b.3% appreciation
c.5% appreciation
d.none of the above
Explanation / Answer
Estimate of the expected (% change) in the value of the AUD over the coming year is calculated below:
Estimate future rate = (-1% × 30%) + (3% × 20%) + (5% × 50%)
= 2.8%
AUD will appreciate by 2.8% in next year.
Hence, Option (A) is correct answer.