What is the rational expectations hypothesis

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1. It is often argued that forward exchange rates should be unbiased predictors of future spot exchange rates if the foreign exchange market is efficient. Is this true or false? Why?

2. What is the prediction of the CAPM for the relationship between the forward exchange rate and the expected future spot exchange rate?

3. If the CAPM explains deviations of the forward exchange rate from the expected future spot exchange rate, explain why one party involved in a forward contract would be willing to enter into a contract with an expected loss.

4. Why is it only the covariance of an asset's return with the return on the world market portfolio that determines whether there is a risk premium associated with the asset's expected return?

5. What is the rational expectations hypothesis, and how is it applied to tests of hypotheses about expected returns in financial markets?

Reference no: EM13897853

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