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One-year interest rates are currently 2.50% in the United States and 3.70% in Great Britain. The current spot rate between the pound and dollar is $1.9000/£. What is the expected spot rate in one year if the international Fisher effect holds?

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Answer:

$1.8780/£

Explanation:

According to the international Fisher effect, the relationship between the interest rate and the exchange rate between two countries A and B, after one year, is:

[tex]F=\frac{1+r_A}{1+r_B}*C[/tex]

Where F is the future exchange rate, r is the interest rate, and C is the current exchange rate.

If the US has an interest rate of 2.50%, the UK has a rate pf 3.70% and the current exchange rate is $1.9000/£, the spot rate in one year will be:

[tex]F=\frac{1+0.0250}{1+0.037}*1.9000\\F = \$1.8780/\pounds[/tex]

In one year, the spot rate will be $1.8780/£.

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