Question 4 Due to the integrated nature of their capital markets, investors in both the U.S....

Transcribed Image Text:

Question 4 Due to the integrated nature of their capital markets, investors in both the U.S. and UK. require the same real interest rate, 2%, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3% in the U.S. and 10% in the UK for next year. The spot exchange rate is currently E$/ = 1.24. a. Compute the nominal interest rate per annum in both the U.S. and U.K., assuming that the Fisher effect holds. b. Using relative PPP, what is the expected future spot dollar-pound exchange rate in one year from now? c. Using UIP, what is the expected future spot dollar-pound exchange rate in one year from now? How does your answer compare with b.? Question 4 Due to the integrated nature of their capital markets, investors in both the U.S. and UK. require the same real interest rate, 2%, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3% in the U.S. and 10% in the UK for next year. The spot exchange rate is currently E$/ = 1.24. a. Compute the nominal interest rate per annum in both the U.S. and U.K., assuming that the Fisher effect holds. b. Using relative PPP, what is the expected future spot dollar-pound exchange rate in one year from now? c. Using UIP, what is the expected future spot dollar-pound exchange rate in one year from now? How does your answer compare with b.?