A Canadian firm is considering purchasing a subsidiary in Great Britain. The subsidiary will cost $\le$6 million and will generate cash inflows of $\le$7.6 million per year at the end of each of the next three years. After that, the company will be worthless. The current exchange rate is $\le$0.83 British pounds per $1. The Canadian inflation rate is expected to be 4% over this period. The current risk-free rate of interest in Canada is 5% and the risk-free rate in Great Britain is 8%.

If uncovered interest parity holds, what is the expected spot rate two years from now?

Question

A Canadian firm is considering purchasing a subsidiary in Great Britain. The subsidiary will cost

\le

6 million and will generate cash inflows of

\le

7.6 million per year at the end of each of the next three years. After that, the company will be worthless. The current exchange rate is

\le

0.83 British pounds per $1. The Canadian inflation rate is expected to be 4% over this period. The current risk-free rate of interest in Canada is 5% and the risk-free rate in Great Britain is 8%.

If uncovered interest parity holds, what is the expected spot rate two years from now?

If uncovered interest parity holds, what is the expected spot rate two years from now?

Quizplus · Accepted Answer

Uncovered interest parity suggests that the expected change in exchange rates is equal to the difference in interest rates between two countries. The formula is: Expected Spot Rate = Current Spot Rate * (1 + Interest Rate of Foreign Country) / (1 + Interest Rate of Domestic Country). Applying this: 0.83 * (1 + 0.08)^2 / (1 + 0.05)^2 = 0.881.

A Canadian Firm Is Considering Purchasing a Subsidiary in Great ≤\le≤

A Canadian Firm Is Considering Purchasing a Subsidiary in Great $\le$