Reference no: EM131982679

Interest Rate Parity, Purchasing Power Parity, International Fisher deEffect Separated by more than 3,000 nautical miles and five time zones, money and foreign exchange markets in both London and New York are very efficient. The following information has been collected from the respective areas: Assumptions London New York Spot exchange rate ($/pound) 1.3264 1.3264 One-year Treasury bill rate 1.5% 2.5% Expected inflation rate Unknown 2.0% a. Estimate today's one-year forward exchange rate F between the dollar and the pound using Covered Interest Rate Parity. b. Find approximate expected inflation in London next year. Is it smaller or larger than New York expected inflation? Why? You can do the forecast using PPP or International Fisher Effect. If you use PPP then assume that the Expected exchange rate E(S) is the same as the forward exchange rate F that you found in (a). Then solve for expected inflation in London using PPP formula. If you use International Fisher effect assume that the real interest rates for two countries are the same.