# Interest Rate Parity

**Topics:**Foreign exchange market, United States dollar, Pound sterling

**Pages:**2 (399 words)

**Published:**September 6, 2012

You can alternatively, also write it as 150yen/GBP

Now, we will apply the following formula = 150yen/GBP *(1+interest rate of Japan)/( (1+interest rate of UK) = 150(1+0.01)/(1+0.04) = 145.67308

So one year from now the exchange rate will be 1GBP = 145.67308 Yen answer

Lets verify the above situation:

Suppose you are have GBP 1000 to invest.

Scenerio 1 – Investing in UK

Amount to be received after 1 year = 1000*1.04 = GBP 1040

Scenerio 2 – Investing in Japan

First lets convert the GBP to Yen = 1000GBP*15oYen = 150000Yen Amount received after 1 year = 150000*1.01 = 151500 yen

Lets convert the YEN received to GBP, with the exchange rate calculated above = 151500/145.67308 = GBP 1040 Interest rate parity rests on certain assumptions, the first being that capital is mobile - investors can readily exchange foreign assets for domestic assets and vice versa. The second assumption is that assets have perfect substitutability, following...

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