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 dollarâ€s spot rate for one year ahead, do you think that the forecast error would be smaller when using todayâ€s one-year forward rate of the Singapore dollar as the forecast or using todayâ€s spot rate as the forecast? Briefly explain.
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