1.Suppose that the one-year interest rate is 13percent in the United Kingdom. The expected annual rate of inflation for the coming year is 10.5percent for the United Kingdom and5percent 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 thatexpected annual rate of inflation for the coming year is 10.5percent for the United Kingdom and5percent for Switzerland. The current spot exchange rate is :SFr= 3.20.What is theexpected Swiss franc to pound exchange rate inthreeyears?

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

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

b.Is thepifover- or undervalued according to PPP?

4.Pafis a small country. Its currency is thepif, and the exchange rate with the United States dollar is1.1pifsper dollar. Following are some of the transactions affectingPaf'sbalance of payments during the quarter:

Pafexports 10 millionpifsof local products.

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

Pafinvestors receive $0.1 million of dividends on their foreign shares.

Many tourists visitPafand spend $0.5 million.

Pafpays 1 millionpifsas interest onPafbonds currently held by foreigners.

Pafimports $7 million of foreign goods.

Pafreceives $0.3 million as foreign aid.

Illustrate how the preceding transactions would affectPaf'sbalance of payments for the quarter, including the current account, the financial account, and the official reserves account.