The spot rate for the British pound currently is £.5086 per $1. The one-year forward rate is £.4975 per $1. A risk-free asset in the U.S. is currently earning 4 percent. If interest rate parity holds, what
Rate can you earn on a one-year risk-free British security?

Question

Quizplus · Accepted Answer

The correct answer is A because the interest rate parity formula is: (1 + r_f)^T = (F/S) * (1 + r_f*)where:r_f is the risk-free rate in the domestic currencyr_f* is the risk-free rate in the foreign currencyT is the time to maturityF is the forward rateS is the spot ratePlugging in the given values, we get:(1 + 0.04)^1 = (0.4975/0.5086) * (1 + r_f*)Solving for r_f*, we get:r_f* = 0.0173 = 1.73%

The Spot Rate for the British Pound Currently Is £