Ans.
a) $1 when exchanged for £ at spot rate S = £0.75
£0.75's value after 1 year in UK = 0.75*(1+0.05) = £0.7875
£7875 when exchanged for $ at F = 0.7875/0.77 = 1.02272
Thus, $1 becomes $1.02272 after investing in UK. So, rate of return is 2.2272% per annum.
b) From uncovered interest rate parity condition,
F/S = (1+interest in UK)/(1+interest in US)
=> 0.77/S = (1+0.05)/(1+0.02)
=> S = £0.748/$
Thus, present spot price = $/£0.748
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