Suppose that investors in both Canada and the UK require the same real interest rate of 2.5% on their lending.  Also suppose that there is concensus in the capital markets that the annual inflation rate is likely to be 3.5% in Canada and 1.5% in the UK for the next three years.  The current spot exchange rate is $2.30 per UK Pound.

Required:

a)Compute the nominal interest rate per annum for this three year horizon, assuming the Fisher Effect holds, in:

     i) Canada

     ii) UK

b) According to Interest Rate Parity (IRP), what should the forward rate be for the UK Pound, priced in dollars, for a two year contract?

c) Compute the future spot exchange rates you expect for:

    i) one year from now

   ii) two years from now

  iii) three years from now

Answer rating: 100% (QA)

a To calculate the nominal interest rate per annum we can use the Fisher Effect formula Nominal Inte... View the full answer