A Canadian ﬁrm is considering purchasing a subsidiary in Great Britain. The subsidiary will cost £16 million and will generate cash inﬂows of £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 £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%.[LINE][LINE]If uncovered
Interest parity holds, what is the expected spot rate two years from now?

Question

Quizplus · Accepted Answer

According to uncovered interest parity, 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 + Foreign Interest Rate) / (1 + Domestic Interest Rate). Using the given rates: Expected Spot Rate = 0.83 * (1 + 0.08)^2 / (1 + 0.05)^2 = 0.881.

A Canadian ﬁRm Is Considering Purchasing a Subsidiary in Great