Consider two government securities - one issued in HKD in Hong Kong and the other issued in Australia. Assume that both government securities are one-year bonds - paying the face value of the bond one year from now and have no risk of default. The face values and prices on the two bonds are given by:

a.Compute the nominal interest rate on each of the bonds.

b. Explain the interest parity relation.

c.If today's exchange rate is 8 HK$ per A$, compute the expected exchange rate for next year consistent with the interest parity relation. Explain why.

d.If the expected exchange rate for next year happens to change to 8, what will happen to today's exchange rate? Explain why.