The spot exchange rate for the British pound is 0.65 pounds/dollar.The one-year interest rate in the United States is 5% and the one-year interest rate in Britain is 7%.Based on these rates,what one-year forward exchange rate is consistent with the absence of arbitrage?

Question

Quizplus · Accepted Answer

According to the uncovered interest rate parity (UIP), the forward exchange rate should reflect the interest rate differential between the two countries. In the absence of arbitrage, the forward exchange rate can be calculated using the formula:

Forward exchange rate = Spot exchange rate × (1 + foreign interest rate) ÷ (1 + domestic interest rate)

Substituting the given values:

Forward exchange rate = 0.65 × (1 + 0.07) ÷ (1 + 0.05) = 0.662

Therefore, choice C is the correct answer.

The Spot Exchange Rate for the British Pound Is 0