Suppose that your Dallas-based company does business in the USA and Germany, so your firm carries bank deposits in both dollars and euros. You observe that in Germany, the nominal interest rate is 6% and expected inflation is 5%. In the USA, the comparable nominal interest rate is 4% and expected inflation is 2%. The spot rate for the euro is $1.21 and the one-year forward rate is $1.17.

a. (6 points) If purchasing power parity (PPP) hold, what is the expected spot rate of the euro in one year?

b. (6 points) If interest rate parity (IRP), what should the forward rate be?

c. (6 points) Based on your response to part b and the forward rate you observe in the market, does interest rate parity (IRP) hold? Briefly explain.