Question $2.$

a$.$ Explain, to the best of your knowledge, why arbitrage in spot and forward exchange markets might be expected to make currencies adjust until the coverage interest parity condition holds. $(40$ marks$)$

b$.$ Explain, to the best of your knowledge, why speculation in spot and forward exchange markets might be expected to make currencies adjust until the forward exchange rate equals the expected future value of the spot exchange rate.

$(30$ marks$)$

c$.$ Explain, to the best of your knowledge, using an exchange rate supply and demand diagram why an increase in inflation is likely to cause a currency

depreciation if the country has a floating exchange rate. $(30$ marks$)$