You can buy or sell the £ spot at $1.98 to the pound. You can buy or sell the pound one-year forward at $2.01 to the pound. If U. S. annual interest rates are 5 percent, what must be the approximate one-year British interest rate if interest rate parity holds?

X = 3.45%

Explanation:

Data provided

One year future exchange rate = $2.01

Spot exchange rate = $1.98

Interest rate is USA = 5%

The computation of British interest rate is shown below:-

Assume Interest rate in UK = X%

One year future exchange rate = Spot exchange rate * (1 + Interest rate is USA) : (1 + X%)

$2.01 = $1.98 * (1 + 5%) : (1 + X%)

$2.01 : $1.98 = (1 + 5%) : (1 + X%)

(1 + X%) = 1.05 : 1.01515

X = 3.45%