Question1.

Assume that the U.S. one-year interest rate is 3% and the one-year interest rate on Australian dollars is 6%. The U.S. expected annual inflation is 5% while the Australian inflation is expected to be 7%. The spot exchange rate of an Australian dollar is $0.689. According to the PPP, what is the exchange rate of the AUD after one year?

a)$0.702

b) 6%

c) $0.676

d) $0.689

Question 2.

Why the PPP theory does not hold in reality?