Consider the situation in which the spot exchange rate, E, is 400, and the expected exchange rate a year from now, E^e, is 406, where both E and E^e are measured in units of domestic currency per unit of foreign currency. Also, the domestic nominal interest rate is 5%, the exchange risk premium, _E , is 2%, and the risk premium, , is 3%, where all these values are annual ones, and the risk premia are defined as being on domestic assets in domestic currency (as in lecture). Covered interest parity is valid.

a. What is the foreign nominal interest rate?

b. What is the default risk premium on domestic assets in domestic currency?

c. What is the currency risk premium on domestic assets in domestic currency?

Show how you determine your answers.