Assume that the current exchange rate between the Australian dollar and the U.K. pound is E = 0.66. If interest parity holds, and the Australian interest rate is 5% while the U.K. interest rate is 7%, the expected exchange rate in one year is:
A) 0.87.
B) 0.57.
C) 0.67.
D) 0.47.
E) 0.77.

Question

Quizplus · Accepted Answer

According to interest parity, the expected exchange rate in one year is equal to the current exchange rate multiplied by (1 + foreign interest rate) / (1 + domestic interest rate). Plugging in the numbers, we get:

Expected exchange rate = 0.66 * (1 + 0.07) / (1 + 0.05) = 0.67

Therefore, the answer is C, 0.67.

Assume That the Current Exchange Rate Between the Australian Dollar