1.Suppose that the one-year interest rate is 13 percent in the United Kingdom. The expected annual rate of inflation for the coming year is 10.5 percent for the United Kingdom and 5 percent for Switzerland. The current spot exchange rate is :SFr = 3.20.

Using the precise form of the international parity relations, compute the one-year interest rate in Switzerland, the expected Swiss franc to pound exchange rate in one year, and the one-year forward exchange rate.

2.Suppose that expected annual rate of inflation for the coming year is 10.5 percent for the United Kingdom and 5 percent for Switzerland. The current spot exchange rate is :SFr = 3.20. What is the expected Swiss franc to pound exchange rate in three years?

3.Paf is a small country whose currency is the pif. Twenty years ago, the exchange rate with the U.S. dollar was 2.5 pifs per dollar, and the inflation indexes were equal to 100 in both the United States and Paf. Now, the exchange rate is 0.95 pifs per dollar, and the inflation indexes are equal to 450 in the United States and 230 in Paf.

a.What should the current exchange rate be if PPP prevailed?

b.Is the pif over- or undervalued according to PPP?

4.Paf is a small country. Its currency is the pif, and the exchange rate with the United States dollar is 1.1 pifs per dollar. Following are some of the transactions affecting Paf's balance of payments during the quarter:

Paf exports 10 million pifs of local products.

Paf investors buy foreign companies for a total cost of $3 million.

Paf investors receive $0.1 million of dividends on their foreign shares.

Many tourists visit Paf and spend $0.5 million.

Paf pays 1 million pifs as interest on Paf bonds currently held by foreigners.

Paf imports $7 million of foreign goods.

Paf receives $0.3 million as foreign aid.

Illustrate how the preceding transactions would affect Paf's balance of payments for the quarter, including the current account, the financial account, and the official reserves account.