II. Calculation (35%) 1. A basket of goods cost $100 in the U.S. and 78 in the United Kingdom. If Purchasing Power Parity holds, what is the dollar-pound exchange rate? (5%) 2. Using your answers in question 1, if the expected inflation in U.S. is 2.5% and the expected inflation in U.K. is 3.5%, what is the expected exchange rate between dollar and pound a year later according to the relative purchasing power parity? (5%) 3. If a year later, the exchange rate turns out to be $1.20/, the pound is undervalued or overvalued and by how much? (10%) 4. Explain the possible reasons that the actual exchange rate deviates from the theoretical exchange rate you calculated in question 2. (15%)