Due to the integrated nature of their capital markets, investors in both the United States and the

Question:

Due to the integrated nature of their capital markets, investors in both the United States and the U.K. require the same real interest rate, 2.5 percent, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 3.5 percent in the United States and 1.5 percent in the U.K. for the next three years. The spot is currently $1.50/£.
a. Compute the nominal interest rate per annum in both the United States and the U.K., assuming that the holds.
b. What is your expected future spot dollar-pound in three years from now?
c. Can you infer the forward dollar-pound for one-year maturity?

Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars... Fisher Effect
The Fisher Effect is an economic theory created by economist Irving Fisher that describes the relationship between inflation and both real and nominal interest rates. The Fisher Effect states that the real interest rate equals the nominal interest...