Answer to Question #66817 in Macroeconomics for Ann

Question

Suppose the CFO of a British corporation with surplus cash flow had 40 million pounds sterling to invest last March 20, 2016 and the corporation did not believe it would need to utilize these funds to retool or expand production capacity for 1 year. Suppose further that the interest rate on 1-year CD deposits in US banks was 1%, while the rate on 1 year CD deposits in England (denominated in British Pounds) was 1.5% at the time. Suppose further that the exchange rate at that time was $1.50 per British pound. Assume that the CFO of the British company invests in US CD deposits and holds them until maturity 1 year later.

A) What must the CFO have expected about change in the value of the British pound over the year to believe in March, 2016 that investment in 1year US CD’s would be more profitable than investment in British CD’s.
(You need not supply a specific numerical answer in this part. Simply identify the direction of change in the pound’s value that the CFO was expecting.)

Answer 1

A) The CFO must have expected the depreciation of British pound of more than comparing to US dollar over the year to believe in March, 2016 that investment in 1year US CD’s would be more profitable than investment in British CD’s.