Suppose the 1-year risk-free rate of return in the U.S.is 4% and the 1-year risk-free rate of return in Britain is 7%.The current exchange rate is 1 pound = U.S.$1.65.A 1-year future exchange rate of __________ for the pound would make a U.S.investor indifferent between investing in the U.S.security and investing the British security.

Question

Quizplus · Accepted Answer

To make the U.S. investor indifferent, the future exchange rate should equalize the returns from both investments. Using the formula for interest rate parity: Future Exchange Rate = Current Exchange Rate * (1 + Foreign Interest Rate) / (1 + Domestic Interest Rate). Plugging in the values: 1.65 * (1 + 0.07) / (1 + 0.04) = 1.6037.

Suppose the 1-Year Risk-Free Rate of Return in the U