Question

Assume that initially the pound/dollar FX market is in equilibrium. The current spot rate is 0.75 pounds per USD, E_L/$=0.75. Interest rate on pound deposit in London is 0.5%, while the interest rate on USD deposit in New York is 1.5%. The expected future exchange rate is E^e_L/$=0.7425.

Then, Bank of England announces a 25 basis points increase in UK interest rates (0.25 percentage points). What is the new equilibrium spot exchange rate?

Answer 1

Pg No- Solution 3- Giren data: • The Current Spot Rate is 0.75 pounds per USD • EL/8= 6.75 • Interest Rate on pound deposit in London is = 0.5% According to international Fishers Effect - S - $2 x 100 = ;*- = 0.7526 where p* - foreign interest rate = 0.56% +025% i = home interest rate : 1.5.4 S2 = New Spot interest rate Sirold Spot interest rate = 0.75 0.75 -52 - X100 -0.75 -1.5 S2 0.75 - Sa X100 --075 S2

Pg No- 0.75 - 0,75 + = 0.0075 - - = 0.0075 0.75 -=0.9925 S2 Hence, S2 = 0.76 pounds peo USD ,