Exercise 2 Suppose that the 3-month interest rate on English bonds is 10%. The rate of return for the US bonds of the same maturity is 6%. The spot exchange rate between the dollar and pound is 2 US$/pound.

a. With free financial capital mobility between the two countries, and the bonds from the two countries being perfect substitutes, what should be the expected depreciation for the dollar? Explain the economic intuition for your answer.

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b. Suppose the exchange rate for the future pound contract is 1.99 US$/pound. Is it possible for a North American investor to exploit an arbitrage opportunity?