Suppose that the annual interest rate on a domestic bond is 5 percent and that the expected rate of inflation is 2 percent per year. Further, suppose that the foreign annual interest rate on a similar bond is 6 percent, while the expected rate of inflation is 4 percent per year.

A. Applying the concept of uncovered interest arbitrage to the nominal interest rates, what would you expect to happen to the exchange value of the domestic currency during the year?