An American (USA) car currently costs $18,000 while the equivalent United Kingdom (UK) car costs £10,000. The nominal UK interest rate is 8 per cent and the nominal US interest rate is 5 per cent. The interest rate in the two countries is equal at 2 per cent and the nominal interest rate differential is full explained by expected inflation differentials. (i) Determine the current Purchasing Power Parity (PPP) exchange rate measured as dollars per pound. (ii) Assuming that international investors are risk neutral, calculate the percentage by which the pound is expected to appreciate or depreciate against the dollar. (ii) If the actual inflation rate coincides with the expected inflation rate and absolute purchasing power p holds on a continuous basis, calculate the PPP exchange rate measured as dollars per pound in one time.

1D

A British money financier is managing €10 million and wants to invest it in safe bonds either in France or United Kingdom for one year. The one-year interest rate on such assets is 0.63% in Britain and 0% in France. The one-year forward euro-pound exchange rate is 1.121 €/£ (euros per pound). Assume that the covered interest parity condition (CIP) always holds and to ensure consistency, treat the UK as home country.  What is the current euro-pound spot exchange rate? Explain and show your work.