The one-year interest rate is 3% in the U.S. and 6% in the Eurozone. On the other hand, the one-year inflation is 6% in the U.S. and 10% in the Eurozone. The spot exchange rate is $1.60/.

a)When the 1-year forward market exchange rate is $1.50/. Figure out the one-year forward premium/discount for euro. (20points)

b)What is the equilibrium one-year forward exchange rate based on Interest Rate Parity (IRP)? (20points)

c)What is the equilibrium one-year forward exchange rate based on Purchasing Power Parity (PPP)? (20points) d) Given the difference between the forward market exchange rate of $1.50/ and the equilibrium forward exchange rate based on IRP or PPP,

i) Which currency is underpriced/undervalued on the forward market? Dollar or euro? (20points)

ii) Which position do you want to take for the forward contract? A long position or short position for euro? (20points)