Section C (35 %) Answer all parts of ONE question 7. Suppose investors have 1,000, and can choose between UK and EU bonds for financial investment in international markets. Both type of bonds offer 3% and the current and future nominal exchange rate is equal to 1.15 euros per pound. (a) Suppose now EU interest rate increases from 3% to 5%. Is the interest parity condition respected? (5 marks) (b) Now suppose the investors engage in arbitrage. How will the investors react? What would be the impact on current exchange rate? Discuss. (10 marks) (c) The interest parily condition or the uncovered interest parity (UIP) relation is a bond market equilibrium condition for an open economy that allows for free capital movement. Using the IS-LM-UIP model discuss the relative effectiveness of fiscal and monetary policy in an open economy, in the short run. (20 marks) Section C (35 %) Answer all parts of ONE question 7. Suppose investors have 1,000, and can choose between UK and EU bonds for financial investment in international markets. Both type of bonds offer 3% and the current and future nominal exchange rate is equal to 1.15 euros per pound. (a) Suppose now EU interest rate increases from 3% to 5%. Is the interest parity condition respected? (5 marks) (b) Now suppose the investors engage in arbitrage. How will the investors react? What would be the impact on current exchange rate? Discuss. (10 marks) (c) The interest parily condition or the uncovered interest parity (UIP) relation is a bond market equilibrium condition for an open economy that allows for free capital movement. Using the IS-LM-UIP model discuss the relative effectiveness of fiscal and monetary policy in an open economy, in the short run. (20 marks)