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Michael Zotov, CFA, is the economist and portfolio manager of the Zotov Investment Fund based in Germany. Zotov believes that the Polish economy is due for a significant recovery as a result of governmental austerity programs enacted this year. Nominal interest rates and inflation have begun to trend lower. The current spot exchange rate is 4.6404 Polish Zioty per euro. Zotov believes that there is an opportunity to speculate on the Polish Zioty. Zotov wants to determine an expected exchange price one year from today. Assuming the one-year nominal interest rate for the European Economic Community is 11.76% and the Polish one-year nominal interest rate is 12.3%, what would be the expected exchange rate for the Polish Zioty one year from today?

The formula for uncovered interest rate parity is:

E (S₁) / S₀ = (1 + r_FC) / (1 + r_DC) or (E (S₁) – S₀) / S₀ = %ΔS = [(1 + r_FC) / (1 + r_DC)] – 1

Where:
E (S₁) = expected spot rate in the period, quoted in FC per unit of DC
S₀ = spot rate today, quoted in FC per unit of DC
r_FC = interest rate in the FC
r_DC = interest rate in the DC
%ΔS = percentage change in the spot rate

By substituting:

%ΔS = [(1 + 0.123) / (1 + 0.1176)] – 1
= [1.123 / 1.1176] – 1
= 0.0048
E (S₁) = 4.6404 PZ/EUR × (1 + 0.0048) = 4.6627 PZ/EUR

The Polish Zioty is expected to depreciate 0.48% against the euro over the next year. It will require more Polish Ziotys to convert into euro by next year. This is the case because of higher inflation expectations for Poland that are implied in its nominal interest rate.

The Asian Spec Fund, managed by Jonathan Khamal, CFA, engages in currency speculation for its clients. Based in Paris, Khamal believes that there is an opportunity to speculate on the Malaysian Ringgit. The current spot exchange rate is 4.417 Malaysian Ringgit per euro. Khamal wants to determine an expected exchange price one year from today. Assuming the one-year nominal interest rate for the European Economic Community is 11.76% and the Malaysian one-year nominal interest rate is 7.6%, what would be the expected exchange rate for the Malaysian Ringgit one year from today?

The formula for uncovered interest rate parity is:

E (S₁) / S₀ = (1 + r_FC) / (1 + r_DC) or (E (S₁) – S₀) / S₀ = %ΔS = [(1 + r_FC) / (1 + r_DC)] – 1

where:
E (S₁) = expected spot rate in one period, quoted in FC per unit of DC
S₀ = spot rate today, quoted in FC per unit of DC
r_FC = interest rate on the FC
r_DC = interest rate on the DC
%ΔS = percentage change in the spot rate

By substituting:

%ΔS = [(1 + 0.076) / (1 + 0.1176)] – 1
= [ 1.076 / 1.1176 ] – 1
= - 0.0372
E (S₁) = 4.417 MR/EUR × (1 – 0.0372) = 4.253 MR/EUR

The Malaysian Ringgit is expected to appreciate 3.72% against the euro over the next year. It will require less Malaysian Ringgits to convert into euro by next year. This is the case because of lower inflation expectations for Malaysia that are implied in its nominal interest rate.