Question 2) Covered interest parity says that (1 + i) = (1+i) St where i is the home interest rate and i* is the foreign interest rate, Fit, is the forward price of foreign currency, and St is the spot price of foreign currency. This presumes there are no costs of transacting in foreign exchange markets. Now imagine that a home investor would have to buy foreign currency at the ask price S, and sell foreign currency forward at the bid price F 1. In general, the ask price is greater than the bid price S" > S, and 4+1 > Fel1. So the home investor would choose not to make a foreign investment if 1ti> (1+i) Fi+1 Now from the perspective of the foreign investor, the ask price of home currency in terms of foreign currency is equal to PS, = , i.e. one over the bid price of home currency in terms of foreign currency. Likewise for the foreign investor, the bid price of home currency in the forward market is equal to PF/+1 = pa , i.e. one over the forward ask price of foreign currency in terms of home currency. So the foreign investor will not buy home bonds if PFit1 (1 + i*) > (1+1) PS, From this, using the fact that ask prices are above bid prices, show that there can exist a region of no trade, where the foreign investor will not invest in home bonds, and the home investor will not invest in foreign bonds