a) If interest rate parity is satisfied, there are no opportunities for covered interest arbitrage. What does this imply about the relationship between spot and forward exchange rates when the foreign currency money market investment offers a higher return than the domestic money market investment? [11 marks]

b) Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%, respectively, over the next several years. If the current spot rate for the Mexican peso is $.005, then what is the best estimate of the peso's spot value in 3 years?

[11 marks]

c) How the purchasing power parity theory can help us to predict the changes in foreign exchange rates? [11 marks]