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1. What are the effects of the following on the Yen/U'S dollar exchange rate: (10 pts) (a) an increase in US. imports of merchandise (b) a Federal Reserve purchase of foreign exchange (c) a sharp increase in the US rate of inflation (d) higher US interest rates (e) a surge in foreign direct investment into the US 2. If the yen/dollar exchange is 122 yen per dollar, and the US annual inflation rate is 5% while the Japanese annual inflation rate is 1%, what is the purchasing power parity exchange rate? Is the dollar overvalued or undervalued versus the yen. Is purchasing power parity a good measure of what the exchange rate should be? (10 pts) 3. Assume that the one-year interest rate in New Zealand is 6 percent. The one-year interest rate in the US is 10 percent. The spot rate of the New Zealand dollar is S0.50. The one-year forward rate is S0.54. Does interest rate parity exist? Is covered interest arbitrage feasible for US investors? For New Zealand investors? (15 pts) 4. Cray Research sold a supercomputer to the max Planck Institute in Germany on credit and invoiced 10 million Euro payable in six months. Currently, the six-month forward exchange rate is S1.10/Euro and the foreign exchange advisor for Cray predicts that the spot rate is likely to be $1.05/Euro in six months. a) What is the expected gain/loss from a forward hedge (Spts) b) If you were the financial manager of Cray Research, would you recommend hedging the euro receivable? Why or why not? (5 pts) c) Suppose the foreign exchange advisor predits that the future spot rate will be the same as the forward rate quoted today. Would you recomment hedging in this case? Why or why not? (5 pts) 5. Given the following: The UK inflation rate is expected to decline, while the US inflation rate is expected to rise. British interest rates are expected to rise, while US rates are expected to fall. . a) Using the above information, do you expect, the pound to appreciate or depreciate in the future? Explain. (5pts) b) Explain how you can hedge the above exchange risk using forward contracts, futures contracts and currency options. (6 pts)