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Exchange rate questions

Question # 10:

If the interest rate in the United Kingdom is 8% the interest rate in the US is 10%, the spot exchange rate is $1.75/£ and interest rate parity holds, what must the one-year forward exchange rate?

Question # 11

Suppose all of the conditions in question 10 hold except that the forward rate of exchange is also $1.75/£. How could an investor take advantage of this situation?


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Question 10:

The relationship between forward rate and spot rate can be notated in the following equation:

f 1+IR1 m
- = ( --------- )
s 1+IR2

Also can be written the following way:

f / s = [(1+IR1)/(1+IR2)]^m

Where f = Forward exchange rate
s = Spot exchange rate
IR1 = US's interest rate (10%)
IR2 = UK's ...

Solution Summary

There are two problems here regarding exchange rate between US and UK.