4. Money and foreign exchange markets in London and New York are very efficient. The following information is available:

Spot exchange rate ($/) One-year treasury-bill rate Expected inflation rate

London New York 1.3860 1.3860 3.8% 4.2% unknown 2%

1. What do the financial markets suggest for inflation in Europe next year? (Use Generalized Fisher Effect)

2. Estimate todays one-year forward exchange rate between the dollar and the euro? (Use Interest Rate Parity)

3. Estimate the expected future spot exchange rate one year from now given the above information. (Use International Fisher Effect)