Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction costs, the investor should invest in the U.S. security.

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Interest rate parity suggests that the difference in interest rates between two countries is offset by the forward exchange rate. Here, the forward rate ($1.44/£) is higher than the spot rate ($1.43/£), indicating that the British security offers a better return when accounting for currency exchange, making it more attractive than the U.S. security.

Use Interest Rate Parity to Answer This Question