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Answer: 1.25%.
**Explanation:** Uncovered interest rate parity (UIP) states that the expected change in the exchange rate should equal the interest rate differential between two countries. Formula: %ΔS(expected) = i_foreign - i_domestic Where: - %ΔS(expected) = expected percentage change in spot exchange rate (foreign currency per domestic currency) - i_foreign = foreign interest rate - i_domestic = domestic interest rate Given: - NZD (domestic): 6.25% - GBP (foreign): 7.50% Expected NZD appreciation = 7.50% - 6.25% = 1.25% Since NZD has the lower interest rate, uncovered interest rate parity predicts it should appreciate relative to GBP by the interest rate differential of 1.25%.
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| Currency | New Zealand | United Kingdom |
|---|---|---|
| New Zealand dollar (NZD) | GBP | |
| 1-year MRR | 6.25% | 7.50% |
| Inflation rate (annual) | 4.00% | 6.00% |
Over the next year, if uncovered interest rate parity holds, the NZD is expected to appreciate:
A
1.25%.
B
2.00%.
C
2.25%.