Consider a Dutch investor with 1,000 euros to place in a bank deposit in either the Netherlands or Great Britain. The (one -year) interest rate on bank deposits is 3 percent in Great Britain and 4.5 percent in the Netherlands. The (one-year) forward euro-pound exchange rate is 1.565 euros per pound and the spot rate is 1.5 euros per pound . Answer the following questions using the exact equation for UIP and CPI as necessary.

a) what is the ( riskless) euro-denominated return on British deposits for this investor using forward cover? (1 mark)

b) Is there any arbitrage opportunity here? Explain why or why not. Is this an equilibrium in the forward exchange rate market? ( 3 marks)

c) If the spot rate is 1.5 euros per pound and interest rates are as stated. What is the equilibrium forward rate,according to the covered interest parity (CPI) ( 3 marks)

d) Suppose the forward rate takes the value given by your answer to (c). Calculate the forward premium on British pound for the Dutch investor (where exchange rates are in euros per pound ). Is it positive or negative ? Why do investors require this premium /discount in equilibrium ?( 4 marks)

e) If uncovered interest parity ( UIP) holds, what is the expected depreciation of the euro against the pound over one year? ( 2 marks)