The table below shows the information for exchange rates, interest rates and inflation rates in the US and Germany. Answer the following questions
Current spot rate: $1.40/€
One-year forward rate: $1.45/€
Interest rate in the US: 3%
Interest rate in Germany: 5%
Inflation rate in the US: 2%
Inflation rate in Germany: 4%
(b) Find the 1-year forward exchange rate in $ per € that satisfies IRP (interest rate parity) from the perspective of a customer that borrowed $1000 traded for € at the spot and invested in Germany.
(c)There is one profitable arbitrage at these prices. How to conduct the covered interest arbitrage if you can either borrow $1000 in the US or €1000 in Germany? What would be the profit?
(d)Explain how the IRP (interest rate parity) will be restored as a result of covered arbitrage activities.
(g) Is it the forecasted by IFE future spot rate (in (f) above) the same as the one forecasted by relative PPP (in (e) above) ? If yes, why so, if no, why not?