Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day)return.In the U.S. ,90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day)return.In the 90-day forward market,1 British pound equals $1.70.If interest rate parity holds,what is the spot exchange rate ($/£)? Do not round the intermediate calculations and round the final answer to four decimal places.
A) $1.7084
B) $1.8280
C) $1.8109
D) $1.8793
E) $2.0159

Question

Quizplus · Accepted Answer

Interest rate parity implies that the forward exchange rate should equal the spot exchange rate adjusted for the interest rate differential. Using the formula: Forward Rate = Spot Rate * (1 + Interest Rate Domestic) / (1 + Interest Rate Foreign), we solve for the spot rate: Spot Rate = Forward Rate / ((1 + Interest Rate Domestic) / (1 + Interest Rate Foreign)). Substituting the given values: Spot Rate = 1.70 / ((1 + 0.01) / (1 + 0.015)) = 1.7084.

Suppose 90-Day Investments in Britain Have a 6% Annualized Return