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9. (10 pts.) Suppose you work for a U.S. firm. You receive the following quarterly Consumer Price Index (CPI) information for the US and the
9. (10 pts.) Suppose you work for a U.S. firm. You receive the following quarterly Consumer Price Index (CPI) information for the US and the UK from the first quarter of 2018 to the third quarter of 2019. You also receive Spot rates of the British pound during that period. Your job is to generate estimates of the equilibrium exchange rates using PPP and make a forecast of the spot rate for the second quarter of 2019 using the forecasted inflation rates provided by the consumer price research team in your firm: Date CPI USCPI UK Inflation InflationPPP Estimate Actual Forecast Error US (s)UK (uK SE 2018:1 2018:II 2018:III 2018:IV 108.6 106.2 1.9754 1.9914 1.7705 108.2 109.3 108.4 106.1 2019:I11 109.7 106.9 112.3 109.1 108.6 1.4378 2019:I 1.4381 Determine the equilibrium spot rates from 2018:Il to 2019:II using PPP Determine the forecast errors from 2018:II to 2019:I of the future spot rate based on PPP. Compute the Mean squared error (MSE) of these forecasts. You receive forward rate information for the 90 day forwards during the period 2018:1l to 2019:I, they are: 1.9992 (2018:I1); 1.8123 (2018:II1); 1.5298 (2018:IV) and 1.4401 (2019:1T). Use these rates to compute the MSE of the three-month forward as a forecast of the spot rate. a. b. c. d. Based on the MSEs you calculated in b. and c. what recommendation would you give your boss: to use the PPP based forecast of the future spot rate or rely on the forward to make predictions on future spot rates? Explain your reasons
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