Suppose that the one-year U.S.interest rate is 4% and the one-year U.K.interest rate is 6%.If the current spot rate is $1.80 per pound,what must the one-year forward rate $/pound be according to the approximate covered interest parity?

Question

Quizplus · Accepted Answer

According to the covered interest parity, the forward rate should reflect the interest rate differential between the two currencies. In this case, the U.K. interest rate is higher than the U.S. interest rate, so the pound should be expected to depreciate against the dollar in the future. Therefore, the forward rate should be lower than the current spot rate.

Using the approximate covered interest parity formula:
(1 + U.S. interest rate)/(1 + U.K. interest rate) x Spot rate = Forward rate
(1 + 0.04)/(1 + 0.06) x $1.80 = $1.764

Therefore, the one-year forward rate $/pound should be $1.764, which corresponds to answer choice B.

Suppose That the One-Year U