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Assume that the current exchange rate between $ and Russian Ruble is 30Rb/$. The Russian Central Bank announces that Ruble will not get weaker than 40Rb/$ during the next year. Assume that one-year Ruble interest rate is 10% and one-year $ interest rate is 5%. Do you find the Central Bank’s announcement credible? Explain. (Hint: What does Uncovered Interest Parity (UIP) suggest for the future spot rate?) (Show your calculations!)

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Answer:

The Central Bank's announcement is quite credible as the predicted future spot exchange rate is way below the announced rate of 40Rb/$

Explanation:

Uncovered interest parity says that the one year Future spot rate (F) is linked to the spot exchange rate (S) in the following manner

F = S * (1+ ih) / (1+if)

ih and  if are the interest rates in home country (Russia) and Foreign country (USA)

So, F = 30* (1+0.1)/(1+0.05)= 31.43 Rb/$

So, the Central Bank's announcement is quite credible as the predicted future spot exchange rate is way below the announced rate of 40Rb/$