Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return.In Canada,90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return.In the 90-day forward market,1 British pound equals $1.96.If interest rate parity holds,what is the spot exchange rate?

Question

Quizplus · Accepted Answer

Interest rate parity implies that the difference in interest rates between two countries is equal to the difference between the forward exchange rate and the spot exchange rate. Using the formula for interest rate parity: Forward Rate / Spot Rate = (1 + interest rate domestic) / (1 + interest rate foreign). Plugging in the given values: 1.96 / Spot Rate = (1 + 0.015) / (1 + 0.01). Solving for the Spot Rate gives approximately 1.9700.

Suppose 90-Day Investments in Britain Have a 6% Annualized Return