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Suppose the US offers a 2% annual interest rate in $ deposits with no risk attached....

Suppose the US offers a 2% annual interest rate in $ deposits with no risk attached.

On the other hand, the UK offers x% annual interest rate in dollar deposits, but there is a 30% probability of default within this year.

What you the minimum value of x need to be for you to put your money in the UK?
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Answer #1

There must be a risk premium in the UK-based rate.

Risk premium = 30% of Risk-free rate

                        = 0.30 × 2%

                        = 0.6%

UK rate = Risk-free rate + Risk premium

            = 2% + 0.6%

            = 2.6% (Answer)

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