Assume that interest rate parity exists. The one-year risk-free interest rate in the U.S. is 3 percent, versus 16 percent in Singapore. You believe in purchasing power parity, and you also believe that Singapore will experience a 2% inflation rate, and the U.S. will experience a 2% inflation rate over the next year. If you wanted to forecast the Singapore dollar’s spot rate for one year ahead, do you think that the forecast error would be smaller when using today’s one-year forward rate of the Singapore dollar as the forecast or using today’s spot rate as the forecast? Briefly explain.
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