Question

1. A £10,000 deposit in a London bank in a year when the interest rate on pounds is

   10 percent and the $/£ exchange rate moves from $1.50 per pound to $1.38 per

   pound.

Answer 1

Deposit amount = £10,000

Exchange rate at the start = $1.5

Deposit amount in dollars = 10,000*1.5 = $15,000.00

Interest rate on pounds = 10%

Deposit amount after a year in pounds = 10,000*(1+10%) = £11,000

Exchange rate at the end of a year = $1.38

Deposit amount after a year in dollars = 11,000*1.38 = $15,180.00

Effective interest rate in dollars = (Deposit amount after a year in dollars/Deposit amount in dollars)-1

= ($15,180.00/$15,000.00)-1 = 1.012-1 = 0.012 = 1.20%