Assume that the U.S. interest rate is 5%, the European interest rate is 2%, and the future expected exchange rate in one year is $1.224. At approximately what exchange rate will the returns between the United States and Europe be equalized?
A) $1.20
B) $1.224
C) $1.188
D) $1.98

Question

Quizplus · Accepted Answer

To equalize returns, we need to set the return on the U.S. investment equal to the return on the European investment. Assuming no change in the exchange rate over that one year period, $1 in the United States will be worth €1.022 ($1 x 1.05/1.02) in Europe one year from now. Therefore, to equalize returns, $1 must be worth €1.022. At the expected future exchange rate of $1.224/€1, this is equivalent to €0.834 ($1/1.224). Thus, the exchange rate that would equalize returns is approximately $1.20/€1 or €0.834/$1.

Assume That the U