Note that this paper uses the standard notation for exchange rates, for example EURUSD 1.1 means “$1.1 for 1 euro”

a. Calculate to 4 decimal place the new exchange rate after a 2% increase in the value of the dollar given an exchange rate of EURUSD 1.1.

b. Given the following exchange rate, calculate the GBPEUR rate to 4 decimal places. EURUSD 1.1043 GBPUSD 1.2970

GBPEUR ?

c. Explain the relationship between your answer to part b) above and triangular arbitrage.

Question 2

Consider the following data: Date Exchange rate January 2017 EURUSD 1.100 December 2017 EURUSD 1.144 Take the US dollar as the home currency a. According to Purchasing Power Parity which currency area should have had the higher rate of inflation in 2017 and by how much? b. If inflation in the US were 3% higher than in the euro area, calculate the change in the real value of the What are the implications of this change? c. What are the implications of a change in the real exchange rate of a currency? d. Explain why you would expect interest rates in the US to be higher than in the euro e. Explain why you would expect there to be no difference in the interest rates of government bonds of any two countries in the euro area and also explain why in practice there are