Homework Sourse15 points Below is information on interest ratesinflation ra
15 points. Below is information on interest rates,inflation rates, and a spot and 1-year foryard exchange rate for the US dollar and the British Pound Interest rate (1-yr Inflation rate (consumer prices, Interbank Spot Forward rate( bond) latest) rate yr) 1 GBP- $1.3134 1.3363 USD 2.7641% +2.8% USD GBP 0.9612% +2.4% interest rates are LUIBQR all accessed July 2, 2018. R interbank rates;exchange and forward tates from investing.com inflation rates from The Economist a.) determine the future expected spot rate that would be predicted to apply in 1 year by Uncovered Interest Parity. What would UIP predict to happen to the relative value of b.) determine the future expected spot rate that would be predicted to apply in 1 year by Purchasing Power Parity. What would PPP predict to happen to the relative value of the dollar over the next year? c.) For each prediction, is the prediction a good fit for the octual forward rate indicated above? Based on your theoretical understonding of UIP and PPP (and their limitations), discuss possible reasons for any deviation of the market forward rate from the values predicted in (o) and (b) ge2012 700 words uk English (US) b-11 ? 0 
Solution
A ) GBPUSD=$ 1.3134
Expected Spot Rate based on UIP:
S*(1+idomestic)/(1+iforeign)
= 1.3134*(1 +0.027461)/(1+0.009612)
=$ 1.3362
(Dollar depreciated against GBP).
B) Based on Purchase power parity the exchange rate will be:
S*(1+inflation in domestic country)/(1+inflaition in foreign country)
=1.3134*(1+0.028)/(1+0.024)
= 1.31853
(Dollar depreciated against GBP)
C) UIP and Purchase power parity rarely hold in the short run. If UIP was valid then carry trade would not be possible. Traders have made a killing buy conducting carry trade between Yen and emerging market currencies. Purchase power parity does not hold because of:
