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Assume that the following regression model was applied to historical quarter: ef= a0 + a1INTt +a2INFt-1 +u INTt= the average real interest rate differential (U.S.

Assume that the following regression model was applied to historical quarter:

ef= a0 + a1INTt +a2INFt-1 +u

INTt= the average real interest rate differential (U.S. interest rate minus the Euro interest rate) over period t.

INTt-1- inflation differential (U.S. interest rate minus Euro inflation rate) in the previous period.

a0, a1, and a2= regression coefficients

= error term

Assume that the regression coefficients were estimated as follows:

0= 0.0

1= 0.45

2= 0.28

Assume that the inflation differential in the most recent period was 2.85%. The real interest rate differential in the upcoming period is forecasted as follows:

Interest Rate Differential

Probability

0%

25%

1%

30%

2%

45%

If a company uses this inflation to forecast the Euros exchange rate, what will be the probability distribution of the Euros percentage change over the upcoming period?

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