(2)A U.S based MNC, wants to forecast the value of the UK pound sterling to assist the corporation make some vital financial decisions. For this purpose, the MNC developed and estimated a regression model. The results are presented below.

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Et= 0.004 + 0.8IIt-1-0.9Rt

where Et =% change in the exchange rate for the pound sterling

IIt-1 = inflation rate differential (U.S & UK)

R = real interest rate differential (U.S & UK)

(a)Briefly comment on the appropriateness or otherwise of the relationships suggested by the estimated parameters.

(b)Suppose the MNC developed a probability distribution for the variable with the instantaneous impact as follows:

Possible outcomes(%)-21.52

Probability (%)405010

Determine the expected percentage changes in the external value of the pound over the upcoming period assuming the lagged inflation rate differential is 2%.

(c )Based on the results in part (b), find the expected value of the percentage change in the value of the pound sterling.

(d)Use the value determined in part (c) to find the exchange rate for the pound sterling given that the spot rate is $1.60.