Suppose the interest rate on 6-month treasury bills is 7 percent per year in the United Kingdom and 4 percent per year in the United States. Also, today's spot exchange price of the pound is $2.00 while the 6-month forward exchange price of the pound is $1.98. By investing in U.K. treasury bills rather than U.S. treasury bills, and covering exchange-rate risk, U.S. investors earn an approximate extra return for 6 months of:

Question

Quizplus · Accepted Answer

The interest rate differential is 3% (7% - 4%) annually, which is 1.5% for 6 months. The forward discount on the pound is 1% (2.00 - 1.98) / 2.00. The net extra return is 1.5% - 1% = 0.5% for 6 months.

Suppose the Interest Rate on 6-Month Treasury Bills Is 7