Suppose 90-day investments in Britain have a 6.00% annualized return and a 1.50% quarterly (90-day)return.In the U.S. ,90-day investments of similar risk have a 4.00% annualized return and a 1.00% quarterly (90-day)return.In the 90-day forward market,1 British pound equals $1.85.If interest rate parity holds,what is the spot exchange rate ($/£)? Do not round the intermediate calculations and round the final answer to four decimal places.

Question

Quizplus · Accepted Answer

The spot exchange rate can be calculated using the interest rate parity (IRP) formula, which is: $F = S \times \frac{(1 + i_{foreign})}{(1 + i_{domestic})}$, where $F$ is the forward rate, $S$ is the spot rate, $i_{foreign}$ is the foreign interest rate, and $i_{domestic}$ is the domestic interest rate. Given that the forward rate ($F$) is $1.85, the quarterly (90-day) return for Britain (foreign) is 1.50%, and for the U.S. (domestic) it is 1.00%, we can rearrange the formula to solve for $S$: $S = F \times \frac{(1 + i_{domestic})}{(1 + i_{foreign})}$. Plugging in the given values: $S = 1.85 \times \frac{(1 + 0.01)}{(1 + 0.015)} = 1.85 \times \frac{1.01}{1.015} = 1.85 \times 0.995074$, which equals approximately $1.8592.

Suppose 90-Day Investments in Britain Have a 6