The interest rate on South Korean government securities with one-year
maturity is 4 percent, and the expected inflation rate for the coming year
is 2 percent. The interest rate on U.S. government securities with oneyear maturity is 7 percent, and the expected rate of inflation is 5 percent.
The current spot exchange rate for Korean won is $1 = W1,200.
Forecast the spot exchange rate one year from today. Explain the logic
of your answer.
Two countries, Great Britain and the United States, produce just one
good: beef. Suppose the price of beef in the United States is $2.80 per
pound and in Britain it is £3.70 per pound.
a. According to PPP theory, what should the dollar/pound spot exchange
rate be?
b. Suppose the price of beef is expected to rise to $3.10 in the United
States and to £4.65 in Britain. What should the one-year forward
dollar/pound exchange rate be?
c. Given your answers to parts a and b, and given that the current interest
rate in the United States is 10 percent, what would you expect the
current interest rate to be in Britain?
