Two countries, Great Britain and the United States, produce just one good: beef.

Suppose the price of

beef in the United States is $2.80 per pound and in Great Britain it is £3.70 per pound.

A.) According to the PPP theory, what should the dollar/pound spot exchange rate be?

The exchange rate for United States and Great Britain is calculated as follows: $2.80/£3.70 = $0.75/£

B.) Suppose the price of beef is expected to rise to $3.10 in the United States and to £4.65 in Britain. What

should the one year forward dollar/pound exchange rate be?

The exchange rate for rise in price is calculated the same way: $3.10/£4.65 = $0.67/£

C.) Given your answers to parts A and B, and given that the current interest rate in the United States is

10%, what would you expect the current interest rate to be in Britain?

As we can see from our calculations above, the dollar is appreciating relative to the pound, and given the

relationship of the International Fisher Effect, the British must have higher interest rates than the United States.

This is proved via the following formula: (S1 – S2)/S2 * 100 = i£ + i$ and is calculated as follows:

(.76 - .67)/.67 * 100 = 13.4 + 10 = 23.4%