R* is the current foreign interest rate
R is the current domestic interest rate
The formula I found on the web looking at different sources looks a bit different from the one you have listed
See this for reference Powered by Google Docs
Hi there, i'm reviewing a past paper for an upcoming test and I can't figure out how you get the answer for the following question:
1. (a) Suppose there is perfect capital mobility between the UK and the Eurozone and investors are risk-neutral. Over the next year, the pound sterling is expected to depreciate against the euro by 5% with a probability of 10%, to appreciate against the euro by 5% with a probability of 20%, and to retain its value against the euro with a probability of 70%. If the one-year interest rate on pound deposits is 5%, what should be the one-year interest rate on euro deposits?
I have applied the Uncovered Interest Parity Formula: R = R* + (Ee - E) / E
Where I believe:
R = 0.05
R* = ? (This is what we are trying to identify)
The answer provided by the examiner is: 5.5%
Please could someone give me some guidance as to how I should approach this question? Thanks for your help!
R* is the current foreign interest rate
R is the current domestic interest rate
The formula I found on the web looking at different sources looks a bit different from the one you have listed
See this for reference Powered by Google Docs
Hello,
Your problem relates to mathematical expectations. To solve this problem, you should be aware of probability and expected value.
If X is a random variable which can take anyone of the values X(1),X(2)………X(n)with respective probabilities P(1),P(2),P(3),…………P(n)then the mathematical expectation ( or expected value )of X usually denoted by E(X) is defined as
E(X)=P(1)X(1)+P(2)X(2)+P(3)X(3)+………………P(n)X(n)
Where each P(i) ≥0 and P(1) + P(2) +P(3)+…………P(n)=1
If you do some home work on probability and expected value, you will definitely get the answer provided by the examiner