Consider a Dutch investor with 1000 euros to place in a bank deposit in either the Netherlands or Great Britain.The(one-year) interest rateon bankdepositsis2% onpounds inBritainand4.04%oneurosintheNetherlands. The(one-year)forwardeuro-poundexchangerateis1.575eurosperpoundandthespot rateis1.5eurosperpound.Answerthefollowingquestions, usingtheexactequationsforUIPandCIP asnecessary.

a. If they invest 1000 euros in Dutch euro deposits, how many euros will they have in one year's time?

b. What is the (riskless) amount of euros they will have in one year if they invest 1000 euros in British pound deposits and use forwards to cover risk?

c. Is there a riskless arbitrage opportunity here? Explain why or why not. Is this an equilibrium in the forward exchange rate market?

d. If the spot rate is 1.5 euros per pound, and interest rates are as stated, what is the true equilibrium forward rate, according to exact covered interest parity (CIP)?

e. If exact uncovered interest parity (UIP) holds, what is the expected depreciation of the euro (against the pound) over one year? What then is the expected euro-pound exchange rate one year ahead?