2. Answer all parts of this question showing the formulae you use for your calculations. 10 3 As an advisor to a pension fund, you are asked to forecast the spot exchange rate between the currencies of countries A and B in the next period. The information below is the only data at your disposal. Assume that today's price level is calculated on a basket of consumption goods that includes the four items below and gives each item a weight of one quarter. The inflation rates for countries A and B are expected to be, respectively, 2% and 9%. You are also told to assume that the nominal interest rate is 3% in country A and 12% in country B. 4MG USB1 1 1 key haircut aspirin apple Country A price of individual goods in representative consumption basket, in local currency, at timet 100 3 2 Country B price of individual goods in representative consumption basket, in local currency, at timet 55 60 15 7 a. What is the exchange rate today if Absolute Purchasing Power Parity holds (APPP)? [3 marks] b. What is the expected exchange rate in the next period according to the Uncovered Interest Parity condition? [3 marks) c. What is the APPP exchange rate next period? [3 marks) d. What is the expected exchange rate in the next period if you assume that Relative Purchasing Power Parity holds? [3 marks] e. Making reference to the fundamental equilibrium relationship, provide a thorough explanation of why the two predictions you obtained in (b) and (d) are different. [8 marks) f. Using the data above, show that testing whether APPP holds is equivalent to testing that the Real exchange rate is one and testing whether RPPP holds is equivalent to testing that the real exchange rate is constant. Make use of the appropriate formulae and also explain the intuition. [7 marks)