Assume there are two countries, Australia and Japan, each produces a similar basket of goods and services. Suppose the price of this basket of goods and services in Australia is AU$500 and the price of the same basket of goods and services in Japan is 50000. Calculate the following:

(a) According to PPP theory, calculate the dollar/yen and yen/dollar spot exchange rate.

(b) Suppose over the next 12 months the price of the basket is expected to rise to AUD$600 in Australia and to 65000 in Japan. Calculate the one-year forward dollar/yen exchange rate. Comment on the new rate compared to the rate in answer (a).

(c) Given your answers to (a) and (b) above, and given that the current interest rate in Australia is 3% per annum, what would you expect the current interest rate to be in Japan?

(d) If Japans nominal interest rate is 15% and inflation rate is 8%, what should be the real interest rate in Japan?

(e) You have a television manufacturing industry in China. In mid-June, you received an order from Australia for exporting 1000 TV sets. Payment of $1,000,000 is due in mid-December. You expect the dollar to fall from $1= 6 to $1= 5 by December. You can borrow dollar at 5% a year in China. Interest rate in Chinese bank is 4% a year. Required:

(i) Explain the implications to your business due to the change in the exchange rate.

(ii) Also discuss your strategy to face the foreign exchange risk if any due to the expected change in the exchange rate.