United States Great Britain Investor’s Required Rate of Interest (real) 2.25% 2.
ID: 2778565 • Letter: U
Question
United States
Great Britain
Investor’s Required Rate of Interest (real)
2.25%
2.25%
Nominal interest rate
9.0
12.75
Spot Rate
$1.56/ £
6-month forward rate
$1.54/ £
Call premium at strike price of $1.56
2.25%
With the above information, determine the following:
1. Future dollar spot rate in 6 months of the dollar to the £.
2. Using the Fisher Effect relationship, determine the expected inflation.
3. Determine the IFE.
United States
Great Britain
Investor’s Required Rate of Interest (real)
2.25%
2.25%
Nominal interest rate
9.0
12.75
Spot Rate
$1.56/ £
6-month forward rate
$1.54/ £
Call premium at strike price of $1.56
2.25%
Explanation / Answer
a. Forward Premium or Discount rate = (Spot rate - forward rate)/Spot rate x 360/days
Forward Premium Rate = (1.56 - 1.54)/1.54 x 360/180 = 2.60%
Future dollar rate = $1.56 x (1+ 2.60%) = $1.60
b. (1 + nominal rate) = (1 + real rate) x (1 + inflation rate)
(1 + 9%) = (1+ 2.25%) x (1+inflation)
inflation = 6.60% USA
Great Britain = (1 + 12.75%) = (1+ 2.25%) x (1+inflation)
inflation = 10.27%
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