3. Suppose that one-year interest rate is 12% for the British pound and 9% for the...
3. Suppose that one-year interest rate is 12% for the British pound and 9% for the U.S. dollar. (a) If the current exchange rate St = $1.63/£, what is the expected future exchange rate in one year? (5 marks) (b) Suppose a change in expectations regarding future U.S. inflation rate causes the expected future spot rate to decline to $1.52=£. By how much would the U.S. interest rate change? (5 marks)
Homework Answers
(3)
(a) British Interest Rate = 12%, US Dollar Interest Rate = 9%, Current Exchange Rate = $1.63 / £
Expected Future Exchange Rate = 1.63 x [1.09/1.12] = $ 1.586 / £
(b) Approximate Change in USD Interest Rate ~ % Change in $ Value Relative to the £
% Change in USD Interest Rate ~ [(1.63 - 1.52) / 1.63] x 100 = 6.748 % ~ 6.75 %
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