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Expected rate of depreciation

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Reference no: EM133065056

Suppose that, as a result of various factors, the R/$ exchange rate is expected to strengthen from its current level of around R13.50/$ to around R.11.50/$.

a) What effect would this have on xa, the expected rate of depreciation? In which direction would uncovered capital flows move?

b) How would traders and speculators in the forward market react to this change in expectations, and what would be the effect on the forward margin (FM)?

c) Given the change in FM identified in (b) above, explain the role of covered interest arbitrage in restoring the covered interest parity condition.

Reference no: EM133065056

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