1. Discuss the effects of a rise in the interest rate paid by euro deposits on the exchange rate. Carefully explain with the help of a graph. Clearly state assumptions, if any.
2. a) In 2013, the price of a big Mac in the USA is 4.2 US $. In the same year in UAE the big Mac costs 20 Dirhams. The nominal exchange rate in UAE was 4.31 Dirham/US $. Does the PPP theory hold when comparing the prices of the big Mac across the two countries? Show your calculations and conclude whether the Dirham is overvalued or undervalued, and if yes, then by what percentage?

b) What are two disadvantages that UAE has given an overvalued exchange rate? (Hint: Remember that oil is priced in US dollars)

c) Does PPP hold in the actual world? Give three reasons to support your answer