Assume that the interest rate is 16% on pounds sterling and 7% on euros. At the same

Question:

Assume that the interest rate is 16% on pounds sterling and 7% on euros. At the same time, inflation is running at an annual rate of 3% in Germany and 9% in England.
a. If the euro is selling at a one-year forward premium of 10% against the pound, is there an arbitrage opportunity? Explain.
b. What is the real interest rate in Germany? In England?
c. Suppose that during the year the changes from €1.8: £1 to €1.77: £1. What are the real costs to a German company of borrowing pounds? Contrast this cost to its real cost of borrowing euros.
d. What are the real costs to a British firm of borrowing euros? Contrast this cost to its real cost of borrowing pounds.

Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars...