It is often argued that forward exchange rates should be unbiased predictors of future spot exchange rates if the foreign exchange market is efficient. Is this true or false? Why?
What will be an ideal response?
Market efficiency means that asset prices accurately incorporate all available information and expected returns on assets correspond to true sources of risk. If forward rates are biased predictors of future spot exchange rates, the source of the bias could be an equilibrium risk premium. Thus, the claim that forward exchange rates should be unbiased predictors of future spot exchange rates if the foreign exchange market is efficient is wrong.
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