Suppose a pair of sneakers costs $250 in Country X and Y25,000 in country Y, where $ and Yen are the respective currencies of X and Y. Assume that both countries have flexible exchange rate systems, i.e. the exchange rate between the two countries is fully floating.

(i) Based on the Law of One Price, what is the exchange rate between the two currencies?

(ii) Due to differences between the rate of inflation in the two countries, suppose the exchange rate between $ and V is predicted to change from part (i) above to 1$ = 105Y. If the rate of inflation in country X is 2%, what would you predict the inflation rate to be in Country Y based on PPP theory? Please explain your answer.

(iii) Suppose the nominal interest rate in Country X is 4%. Based on the answer to part 2 above, what the Fisher Effect imply about the nominal interest rate in country Y.