Suppose the US investor in Question 8 were risk averse, instead of risk neutral, and wants a risk premium of \(1 \%\) (annual) for assuming the exchange-rate risk on the international investment.
a. Find the expected spot exchange rate that would make the risk-averse investor indifferent between the US and British risk-free investments.

b. Demonstrate that the investor would earn that return if this expected exchange rate is realized.

Question 8:

Explain why a risk-neutral investor would be indifferent between a one-year US dollar investment in a risk-free security at \(3 \%\) and a one-year British pound investment at \(5 \%\) if the investor expected the \(\$ / £\) spot exchange rate one year later to equal the forward rate as determined by the IRPT. In your explanation, assume the current spot exchange rate is \(\$ 1.50 / B P\).