The following rates currently exist:

Spot exchange rate: $1.00/euro

Annual interest rate on 180day eurodenominated bonds: 3%

Annual interest rate on 180day

US dollardenominated bonds: 4%

Investors currently expect the sp

ot exchange rate to be $1.005/

euro in 180 days.

a.

Show that uncovered interest rat

e parity holds (approximately)

at these rates. (5 points)

b.

Suppose the return on US dollar

denominated bonds falls to 3%.

What is the likely effect on the spot rate? If

uncovered interest rate parity i

s reestablished, what will the

new current spot rate b

e (holding all other

variables constant)? (8 points)

c.

Has the dollar appreciated or depreciated? (4 points)

d.

Suppose investors now expected the spot exchange rate to be $1.

0075/euro in 180 days. What is the likely

effect on the spot rate? If uncovered interest rate parity is r

eestablished, what will the new current spot

rate be (holding all ot

her variables consta

nt)? (Use the new US

interest rate of 3% in your calculations.) (8

points