International Financial Management 6th Edition by Sanjiv Eun, Cheol Resnick, Bruce Sabherwal

Exercise 23

Due to the integrated nature of their capital markets, investors in both the U.S. and U.K. require the same real interest rate, 2.5%, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3.5% in the U.S. and 1.5% in the U.K. for the next three years. The spot exchange rate is currently $1.50/£.
a. Compute the nominal interest rate per annum in both the U.S. and U.K., assuming that the Fisher effect holds.
b. What is your expected future spot dollar-pound exchange rate in three years from now
c. Can you infer the forward dollar-pound exchange rate for one-year maturity