Suppose interest rates in the United States are 5.5%, while they are 3% in the euro...
Suppose interest rates in the United States are 5.5%, while they are 3% in the euro area. Currently the dollar–euro exchange rate is at $2.50 per euro. If UIP holds, what do you expect the exchange rate to be in the future? Round to three decimals.
Homework Answers
- The UIP or the uncovered Interest rate parity is the difference in the interest rates between two countries that will equal the change in exchange rates.
- Given that the interest rates in US are 5.5% and in the euro area the interest rates are 3%, it is also given that the change in exchange rates between these two countries equals $2.50.
- If UIP holds, then the exchange rate in future can be calculated as:-
$2.50 * (1+5.5% - 3%) = $2.563.
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