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

$1.49 Excluding Tax

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QUESTION:

Due to the integrated nature of their capital markets, investors in both the U.S. and U.K. require the same real interest rate, 2.5%, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3.5% in the U.S. and 1.5% in the U.K. for the next three years. The spot exchange rate is currently $1.50/£.

a. Compute the nominal interest rate per annum in both the U.S. and U.K., assuming that the Fisher effect holds.

b. What is your expected future spot dollar-pound exchange rate in three years from now?

c. Can you infer the forward dollar-pound exchange rate for one-year maturity?


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