The one-year forward exchange rate for the British Pound is $1.70/Pound. If the one-year Australian interest rate is 5% and the one-year British interest rate is 6%, compute the implied spot exchange rate in $/Pound.

Question

Quizplus · Accepted Answer

Let S be the current spot exchange rate.
Then, the interest rate parity (IRP) condition gives:
(1 + 0.06) = (1 + 0.05) x (S / 1.70)
S = 1.72
Therefore, the implied spot exchange rate in $/Pound is 1.72.

The One-Year Forward Exchange Rate for the British Pound Is