Suppose a Big Mac costs CAD6.88 in Canada and USD5.71 in the United States. The nominal exchange rate between the two currencies is CAD1.36 = USD1.00.

(a) Calculate the real exchange rate?

(b) Which currency is undervalued, CAD or USD? Explain.

Answer parts (c) and (d) using information in Table 1.

(c) France, Germany and Italy use the same currency (Euro) and hence have a fixed exchange rate with one another. What are the risk premiums on the French and Italian government bonds implied by the interest rates in the table?

(d) Germany and the USA do not have a fixed exchange rate between their currencies. If the uncovered-interest-parity condition holds, what could explain the difference between the interest rates on the German and the US government bonds?