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4. Suppose that the exchange rate adjusts so that interest-rate parity holds. Further, suppose the interest rate on a one-year South Koran bond is 6 percent and the interest rate on a one-year U.S. bond is 2 percent. a) If you expect the exchange rate in one year to be 1,100 South Korean won per USD, what is the exchange rate today

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Tundexi

Answer:

The exchange rate today is 1,058.5

Explanation:

Interest rate on 1 year South Korean bond = 6% or 0.06

Interest rate on 1 year U.S. bond = 2% or 0.02

Expected Exchange rate in 1 year = 1,100 South Korean won per USD. Let the Exchange rate today = x

[(Interest rate on South Korean bond - Interest rate on U.S. bond)/(1 + Interest rate on 1 year U.S. bond)] + 1 = (Expected Exchange rate in 1 year)/(Expected Exchange rate today)

[(0.06 - 0.02)/(1 + 0.02)] + 1 = 1,100/x

x = [0.04/1.02] + 1 = 1,100/x

x = 1,100/1.0392

x = 1,058.50

So therefore, the exchange rate today is 1,058.5

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