1. The interest rates in the $ and the euro are 2% and 5% respectively. If the spot exchange rate is $1/1 euro, what will the expected spot rate be, if the IFE applies?

This is the formula for Interest Rate Differential for Euro Terms (/$):

i$ - i / 1 + i = /^$S - /^$S^ex / /^$S^ex

Given Information:

Interest Rate of Dollar (i$): 2% or 0.02

Interest Rate of Euro (i): 5% or 0.05

Spot Exchange Rate in Euro Terms (/^$S): $1/1 Euro

Expected Spot Exchange Rate in Euro Terms (/^$S^ex):

0.02 0.05 / 1 + 0.05 =

This is the formula for Interest Rate Differential for Dollar Terms ($/):

i$ - i / 1 + i = $/S^ex - $/S / $/S

Given Information:

Interest Rate of Dollar (i$): 2% or 0.02

Interest Rate of Euro (i): 5% or 0.05

Spot Exchange Rate in Dollar Terms ($/S): $1/1 Euro

Expected Spot Exchange Rate in Dollar Terms ($/S^ex):

0.02 0.05 / 1 + 0.05 =

I have been told that 0.05 becomes 0.02 so 1 + 0.02. I don't know if that is right but you can please explain it to me.

I get stuck finding spot exchange rate in euro terms and in dollar terms. Using the formulas that I showed above, please help me find spot exchange rate in euro terms and dollar terms and then help me find expected spot exchange rate in euro terms and in dollar terms. Please show work for both because I would like to know what I am doing wrong. Please explain if the euro or dollar has devalued or revalued. Thank you.