Question

Suppose you have $100,000 to place in a bank deposit in either the United States of Great Britain. The annual interest rate on bank deposits in the United States is = 6% and in Britain is is = 8.5%. The spot US dollar/British pound exchange rate is = 1.9421 and the one-year forward rate is = 1.9933. Answer the following questions using the exact equation for covered interest parity (CIP),    a. if you deposit your money in the US, after one year, your investment will be worth_______.    b. if you convert to pounds and deposit your money in Britain, after one year, your pound-denominated investment will be worth________, Then, converted back to dollars, it will be worth _____________, c. This analysis suggests that:

Answer 1

a) If the Money is deposited in the US, after one year, the investment will be worth $106,000.

b) The pound-denominated investment will be worth 55867.35 pounds. When converted back to the dollar it will be worth $111360.4.

c) The analysis suggests that it will be profitable to invest in Britain.  

Calculations:

Converting dollar into pound 100,000 / 1.9421. = 51490.65

Calculating interest rates = (51,490 x 8.5 x 1) / 1000= 4376.70.

Total amount = 51490.65 + 4376.70 = 55867.35

COnverting back to dolar = 55867.35 X 1.9933