Problem
Due to the integrated nature of their capital markets, investors in both the U.S. and Great Britain require the same real interest rate of 3%. The expected annual inflation in the U.S. is 2% and the expected annual inflation in the U.K. is 5%. The spot exchange rate is currently £1.00 = $1.80. Calculate the current annual interest rates, and the expected future dollar-pound spot rate in one year assuming parity holds.