Question
The current rates are: (1) Spot exchange rate: $2.00/; (2) 90-day USD denominated bonds: 2% (8% annual); (3) 90-day UK pound denominated bonds: 4% (16%
The current rates are: (1) Spot exchange rate: $2.00/; (2) 90-day USD denominated bonds: 2% (8% annual); (3) 90-day UK pound denominated bonds: 4% (16% annual); (4) Current 90 day forward exchange rate: $1.98/ c. If CIP were to hold, and the only thing that could change is the foreign exchange rate, to what value will it be driven?
Assume that the rates in in the previous question were set the day before the Brexit vote, when most expected the referendum to fail. When the final vote came for Leave, assume that expectations for the future $/ exchange rate plummeted to 1.6, as there was uncertainty about the British economy. Interest rates stayed constant (assume UIP was holding at the time). What do you expect to happen to the spot exchange rate today, given that UIP continues to hold (give the answer in % change of the exchange rate).
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