Problem
Due to the integrated nature of their capital markets. investors in both the United States and the UK. require the same real interest rate, 3.9 percent, on their lending. There is a consensus in capital markets that the annual inflation rate is likely to be 4.9 percent in the United States and 2.9 percent in the UK. for the next three years. The spot exchange rate is currently $2.9/£.
1) Compute the nominal interest rate per annum in both the United States and the U.K., assuming that the Fisher effect holds.
2) What is your expected future spot dollar-pound exchange rate in three years from now?
3) Can you infer the forward dollar-pound exchange rate for one-year maturity?