Question

3. Using IFE, assume that the interest rate on a one-year insured home country bank deposit is 6%, and the interest rate on a 1-year insured foreign bank deposit is 8%. For the actual returns of these two investments to be similar from the perspective of investors in the home country, the foreign currency would have to change over the investment horizon by the following percentage:

Answer 1

Assuming $1 = F 1 at the beginning

In home country, the investor would earn 6% interest and the total value is $ 1.06

In foreign country, the investor would receive F 1.08

For home investor to get same return, the home currency should be worth 1.08/1.06 i.e. $1 = 1.018868

So foreign currency changes from $1 to $1/1.018868= 0.98148

So % change is (1-0.98148)*100/1= 1.85%