Suppose the 6-month risk-free rate of return in the United States is 4%. The cur

Question

Suppose the 6-month risk-free rate of return in the United States is 4%. The current exchange rate is 1 pound = US$1.70. The 6-month forward rate is 1 pound = US$1.50. The minimum yield on a 6-month risk-free security in Britain that would induce a U.S. investor to invest in the British security is ________.

Suppose the 6-month risk-free rate of return in the United States is 4%. The current exchange rate is 1 pound = US$1.70. The 6-month forward rate is 1 pound = US$1.50. The minimum yield on a 6-month risk-free security in Britain that would induce a U.S. investor to invest in the British security is ________.

Explanation / Answer

if the same is invested in US, he would get 1*1.04 = 1.04 Dollar

If he investes in Britain, For 1 USD, he would get 0.588235 Pound and due to depreciation of the pound he would get back 0.8823 USD at the end of the 6 months without interest rate

So at the end of the six months, 0.588235*(1+x) = 1.04/1.50 = 0.693333

where x is the interest rate

1+x = 0.693333/0.588235

x = 0.178667

So interest rate in the UK shouls be at least 17.867% for the investpr to invest in the UK

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