1. Suppose that the interest rates in the U.S. and Germany are equal to 5%, that the forward (one year) value of the € is F$/€ = 1$/€ and that the spot exchange rate is E$/€ = 0.75$/€. Please answer the following questions by explaining all steps of your analysis:
a) Does the covered interest parity condition hold? Why or why not?
b)How could you make a riskless profit without any money tied up assuming that there are no transaction costs in buying and or selling foreign exchange?
2. Suppose that two countries, Britain and the U.S. produce just one good - beef. Suppose that the price of beef in the U.S. is $2.80 per pound, and in Britain it is £3.70 per pound.
a) According to PPP theory, what should the $/£ spot exchange rate be?
b) Suppose the price of beef is expected to rise to $3.10 in the U.S. and to £4.65 in Britain. What should be the one year forward $/£ exchange rate?
3. How important is the creation of international banking facilities to the international competitiveness of the U.S. banking industry?