1. One unit of product costs $5.00 in USA and 15 in Europe. Let current spot E$/ = 1.2. Define if the euro is (a) undervalued or (b) overvalued. (4 points)

2. There are two countries, A and B, and they produce some product. The currency unit used in country A is dollar and the currency unit in country B is euro. In country A, the product sells for 30 dollars per unit. The exchange rate is 1.2 dollars per euro, E$/ =1.2. (6 points)

a. If the law of one price holds, what is the price of product in country B, measured in euros?

b. Assume the price of product in country B is actually 35 euros per unit. Calculate the relative price of product in country B versus country A? Where will traders buy product? Where will they sell product? How will these transactions affect the price of product in countries A and B?