Assume that the following regression model was applied to historical quarterly data:

ef,t = a0 + a1INTt + a2INFt-1 + t

where ef,t = percentage change in the JPYUSD exchange rate in period t

INTt = interest rate differential between U.S. and Japan (iUS-iJAP) over period t

INFt-1 = inflation differential between U.S. and Japan (IUS-IJAP) in the previous period

a0, a1, a2 = regression coefficients

t = error term

Assume that the regression coefficients were estimated as follows: a0 = 0.0, a1 = 0.85, a2 = 0.7

Also, assume that the inflation differential in the most recent period was 2%. The real interest rate differential in the upcoming period is forecasted as follows:

(iUS-iJAP) Probability

0% 20%

1 50%

2 60%

2

If Caterpillar Corp. uses this information to forecast the Japanese yens exchange rate, what will be the probability distribution of the yens percentage change over the upcoming period?