Page 36 - Microsoft Word - 00 CIMA F1 Prelims STUDENT 2018.docx

Chapter 1

Example 8

BBL Co is based in country G, where the functional currency is the G$. Some
of BBL Co's suppliers are based in the UK, and they invoice BBL Co in British
pounds (GBP). Therefore, the directors of BBL Co keep a close eye on the
exchange rate between the G$ and the GBP, and they use the interest rate
parity theory to estimate the likely future exchange rates.

The current spot rate is G$/GBP 1.88 (that is G$ 1 = GBP 1.88), and the
expected interest rates in the UK and country G respectively are 5% and 8%
over the next year.

What is the forecast spot rate in one year's time using the interest rate
parity theory and assuming that the current forward rate is the best
forecast of the future spot rate?

A G$/GBP 1.18

B G$/GBP 1.83

C G$/GBP 1.93

D G$/GBP 3.01

Solution

The answer is (B).

The G$ is the base currency and the GBP is the variable, so the forward rate
is 1.88 × (1.05/1.08) = 1.83

28