Subiect 1: Exchange Rates and International Finance (35%4 The manager of a local bookstore named 'Fahrenheit 451' plans to invest 3.5 million euros for one year, and she/he has two alternatives: a US bond with interest rate 1.2%, and a German bond with interest rate 0.9%. Note also that today's euro nominal exchange rate per S equals 0.884. a) If the manager expects annual depreciation of the euro by 4%, what will be his/her choice? [Mark: 0.5 b) Which expectations' scheme regarding the exchange rate will make the manager indifferent between the two alternatives? [Mark: 1.0] B. During a short visit to Poland, you realize that a representative basket of goods and services costs 530 Polish Zloty (PLN). Since you live in the Eurozone, you alread know that the same basket in the Eurozone costs 143 euros. Also, the nominal exchange rate (E) between the two currencies is Ee/pLN 0.23. a) Calculate the exchange rate that is consistent with the PPP and the real exchange rate of the PLN with respect to the euro. Comment on this finding. [Mark 1.0] b) If PPP holds in the long-run, explain which country will gain competitiveness and by how much during the period of adjustment to the long-run equilibrium. What do you expect about the determination of the inflation differential in the long run? [Mark 1.0]