Because the Netherlands is part of the euro zone, the home currency of a Dutch investor is the euro. Assume the Dutch investor is comparing a euro investment strategy with an investment strategy in British pounds. Assume the interest rate in Netherlands is $4\%$ while the interest rate in Britain is $3\%$ over a $1-$year time horizon.

a$.$ Applying the UIP approximation formula, calculate the value of the expected appreciation$/$depreciation of the pound at which the investor would be indifferent between investing in the Netherlands compared to investing in the UK$.$

Assume now that the euro$-$pound spot exchange rate is E$/=1\mathrm{.}2($i$.$e$.1\mathrm{.}2$ euros per pound$)$ while the $(1$ year$)$ forward euro$-$pound exchange F$/=1\mathrm{.}5($i$.$e$.1\mathrm{.}5$ euros per pound$).$

b$.$ Calculate the forward premium.

c$.$ Calculate the risk$-$free euro return from an investment strategy in pounds that uses forward cover.

d$.$ Comparing the $1\mathrm{.}04$ euro return on euro deposits to the euro return on pound deposits you calculated in part c$,$ is there an opportunity for arbitrage?

e$.$ Given the interest rates, are the spot rate of E$/=1\mathrm{.}2$ and the forward rate of F$/=1\mathrm{.}5$ compatible with CIP?

f$.$ Given the interest rates and the spot rate E$/=1\mathrm{.}2,$ what does CIP predict the forward rate to be$?$