Even in the most efficient markets, ‘ideal’ conditions do not exist, and forward premia as a result have not been able to predict future spot rates accurately. The actual exchange rates are usually overvalued or undervalued in terms of the purchasing power parity. Under Indian conditions, however, there are some additional questions.
For instance, which is the correct risk-free interest rate to be compared while calculating interest rate differentials? Should we consider the 91-day T-bill rate or some other short-term rate? The theoretical forward premia could vary depending on the interest rate chosen. In the quest for answers to some questions, dilemmas do arise. Objectives and Purposes of Exchange Rate Management 4.