Money and foreign exchange markets are quite efficient. you have the following i

Question

Money and foreign exchange markets are quite efficient.  you have the following information

                                                                      Sweden                                UK

Spot exchange rate                               BP 0.09697/krona                    krona 10.3125/BP

Expected inflation rate                               .5%pa                                            N/A

Nominal interest rate                                   .9%p.a                                       2.2%

1) What is expected rate of inflation for uk next year

2) what is your estimate of the one year forward exchange rate between the krona and british pound?

Please show and explain

Explanation / Answer

expected rate in sweden is 0.5

expected rate in uk is 0.9 + 2.2 = 3.1

Difference is 3.1 - 0.5 = 2.6%

hence the value of

BP = 0.09697 * 1.026 = 0.09949122/krona

and

krona = 10.3125/1.026 = 10.051169590643275 / BP

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