Question

Given the information above about the Dutch investor, and if Uncovered Interest Rate Parity holds, what is the expected change of the euro against the pound over one year? Consider a Dutch investor with 1,000 euros to place in a bank deposit in eitherthe Netherlands or Great Bntain The one-year interest rate on bank deposits is 2% in Britain and 4.04% in the Netherlands. The one-year forward euro-pound exchange rate is 1.575 euros per pound, and the spot rate is 1.5 euros per pound. The exchange rate will remain constant. 2% appreciation 2% depreciation 5% depreciation

Answer 1

The interest rate differential is euro interest rate - pound interest rate = 4.04% - 2% = 2%. The expected depreciation is (1.575 - 1.5)*100/1.5 = 5%. Hence under the UIP condition the two rates should be same so euro should depreciate by 2 percent

Select 2 percent depreciation.