Question

Use the following to answer the next two questions.

Assume a British investor observes the following situation:

     Current spot rate: £1.10/$

UK 1 year interest rate: .10

US 1 year interest rate: .13

What should be the percentage change in direct quotes according to IFE? Round intermediate steps and your final answer to four decimals and enter your response in decimal format (EX: .XXXX) (Please solve without excel and type in decimal formate .xxxx)

2)What should be the future spot price of dollars in terms of pounds according to IFE? Round intermediate steps and your final answer to four decimals. Do not use currency symbols or words when entering your response.Help please .

Answer 1

As the rates are from a British Investors perspective, the domestic currency is the pound and $ is the foreign currency. Direct Currency Quote is one in which the domestic currency is the quoted currency (pound in this case)

Current Spot Rate = £ 1.1 / $ , US Interest Rate = 0.13 or 13 % and UK Interest Rate = 0.1 or 10%

Using IFE, Expected Future Spot Rate = Current Spot Rate x [1+UK Interest Rate / 1+US Interest Rate] = 1.1 x [1.1 / 1.13] = £ 1.071 / $

% Change in Direct Quote = [1.071 - 1.1] /1.1 = - 0.026363 or - 2.6363 %

Expected Future Spot Rate as per IFE = £ 1.0708 / $ (as calculated earlier)