Consider the following formula E₁st-st/8 = if - i. it, £/$ £/$ where st St £/$ is the logarithm of the nominal exchange rate in period t defined as pounds per dollar, it is the short term interest rate in the UK and it is the short term interest rate in the US.

Consider the following formula E₁st-st/8 = if - i. it, £/$ £/$ where st St £/$ is the logarithm of the nominal exchange rate in period t defined as pounds per dollar, it is the short term interest rate in the UK and it is the short term interest rate in the US.

Macroeconomics

13th Edition

ISBN:9781337617390

Author:Roger A. Arnold

Publisher:Roger A. Arnold

Chapter22: International Finance

Section: Chapter Questions

Problem 10QP

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Question

Solve the question given in the picture.

Consider the following formula
£/$
Et st+1
where St
£/$
St = if — it,
£/$ is the logarithm of the nominal exchange rate in period t defined
as pounds per dollar, it is the short term interest rate in the UK and it is the
short term interest rate in the US.

Consider augmenting the equation as follows:
£/$
Etst/i-sf/8 - (if - i)
£/$
st+1
St
2) What is pt?
a) The Fed Funds rate
b) The equity premium
c) The currency risk premium
d) None of the above
= Pt.

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