Oscar Mendoza is starting off his rotational program in the foreign exchange department of an international investment company. Part of his responsibility involves an assessment between the USD and GBP specific to interest rate parity and expected future spot rates. Mendoza wants to develop a forecast of the exchange rate for the USD relative to the GBP in one year. He is also interested in evaluating interest rate parity between the two countries under covered and uncovered interest rate parity scenarios. To help him in his evaluation, the research department provides him with the following data points:

	Interest Rates	Exchange Rates
	One Year LIBOR (Today)	Currency Pair	Spot Exchange Rate(Today)
GBP	3.00%	CAD/GBP	1.7965
CAD	0.75%	CAD/USD	1.1328
USD	0.10%	USD/GBP	1.5859

During his evaluation, Mendoza is asked to participate in a meeting. He joins a fellow program participant, Diego Costas, and they both listen to the firm's senior economist and research director discuss the attributes of economic growth in developing and developed countries. The firm is committed to making a significant investment in developing countries but has limited prospective exposures exclusively to countries having no trade restrictions and robust natural resource endowments.

The research director points out that free trade, development of natural resources, and a commitment on the part of the government to develop infrastructure and human capital are more significant factors for growth in developing countries than technological progress and capitaltolabor ratios, as these two factors will increase over time naturally.

Following the meeting, Mendoza and Costas step out for lunch and have a discussion based on the opinions they have heard. Mendoza states, "Trade can be influenced by tariffs and other sanctions. These are regulatory channels that are available; however, by imposing these mechanisms, regulators may inhibit growth and impact exchange rates. Additionally, from a country's perspective, trade barriers can limit growth and place it at a disadvantage."

Costas notes, "Technological progress can compensate for trade restrictions and is the foundation for longterm growth."

Mendoza replies, "That technology is important, I am in agreement; but I disagree that a country needs to be a leader in technological progress to have a strong growth trajectory. In fact, many developing countries benefit from being a technology follower and have higher growth rates than developed countries, but free trade is requisite for the growth I am indicating. In the long run, according to standard theory, rates of productivity growth and GDP growth should be higher in developing countries and the gap between developing and developed countries will narrow over time."

1.If covered interest parity holds, the oneyear return to a British investor whose currency exposure to the USD is fully hedged is closest to: BAC

A. 0.10%.

B. 3.00%.

C. 2.90%.

2.If uncovered interest rate parity holds, between today and a year from today, the expected movement in the GBP/USD currency pair is closest to: BAC

A. 3.00%.

B. 2.90%.

C. -2.90%.

3.If uncovered interest rate parity holds, today's expected value for the GBP/USD currency pair one year from now would be closest to: BAC

A. 1.5411.

B. 0.6128.

C. 0.6489.

4.Based on Mendoza's statement, barriers to trade will result in what type of impact to exchange rates and growth, respectively? BAC

A. A trade barrier can enhance the difficulty in assessing purchasing power parity and can create an impediment to economic growth.

B. Tariffs will not impact exchange rates and can assist domestic growth.

C. Tariffs are distortions to trade but promote domestic expansion.

5.The director of research's comments related to longrun growth are most closely aligned with: BAC

A. Growth accounting equation.

B. Labor productivity equation.

C. Capital deepening.

6.What is Mendoza referring to as "standard theory" in his discussion of longrun growth? BAC

A. Neoclassical growth theory.

B. Convergence hypothesis.

C. Endogenous growth theory.