[10 points]

(A). Figure 1: equilibrium exchange rate is at point 1 where expected dollar returns on dollar and euro deposits are equal.

Suppose there is a rise in the dollar interest rate. Discuss the effects of this rise in the dollar interest rate on the exchange rate. [5 points] Expected Dollar Expected Dollar Today's Dollar/Euro Interest Rate on Depreciation Rate Return on Euro Exchange Rate Euro Deposits Against Euro Deposits ES/E RE (1.10- ES/)/ES/E RE + (1.10 - Es/)/ES/E 1.10 0.03 1.08 0.03 1.06 0.03 1.04 0.03 1.02 0.03 Write down the numbers in the space provided for short answer question in the exam, not in the table. [5 points]