Question

if the interest rate in the united kingdom is 7 percent, the interest rate in the united states is 8 percent, the spot exchange rate is $1.742/£1, and interest rate parity?

Answer 1

Interest rate parity suggests that the difference in interest rates between two countries will be equal to the difference in the exchange rates between their currencies. If the interest rate in the United Kingdom is 7 percent and the interest rate in the United States is 8 percent, the expected exchange rate between the British pound and the US dollar can be calculated using interest rate parity.

Step-by-step explanation:

Interest rate parity is an economic theory that suggests that the difference in interest rates between two countries will be equal to the difference in the exchange rates between their currencies. In this case, if the interest rate in the United Kingdom is 7 percent and the interest rate in the United States is 8 percent, we can apply interest rate parity to determine the expected exchange rate between the British pound and the US dollar.

Using the formula:
Expected exchange rate = Spot rate x ((1 + interest rate in the United Kingdom) / (1 + interest rate in the United States))

Let's plug in the given values:
Expected exchange rate = $1.742 x ((1 + 0.07) / (1 + 0.08))

Calculating this, we find that the expected exchange rate between the British pound and the US dollar is approximately $1.693/£1. This means that, according to interest rate parity, the pound is expected to depreciate against the dollar.