Consider the following: an investor in the U.S. is pondering a one-year investment. She can purchase a domestic bond for $1,000 that has an interest rate of i or she can purchase a bond in England for 1,500 British pounds (£) that pays an interest rate of if. The current exchange rate is $1.50/£ . She considers the bonds to be of equal risk. If i = if, the expected returns are not equal. What do you know?
A) The exchange rate is fixed between the U.S. and Britain
B) The bonds initially sold for different prices
C) Arbitrage doesn't work
D) The exchange rate must be flexible

Question

Quizplus · Accepted Answer

The expected returns being unequal despite identical interest rates suggests that the exchange rate between the U.S. dollar and the British pound is expected to change over the investment period, indicating a flexible exchange rate system.

Consider the Following: an Investor in the U