The principle of covered interest parity (CIP), set out by Keynes (1923) during the floating exchange rate period after WWI, is a fundamental building block of international finance. Absent counterparty risk, CIP is a pure no-arbitrage relationship that equates the premium of a currency's forward over its spot exchange rate (both rates expressed as the price of foreign currency) to its nominal interest-rate advantage over foreign currency. Under CIP, for example, for those comparing two ways effectively to borrow US dollars, the US dollar interest rate equals the total cost of borrowing euros, buying dollars in the spot foreign exchange market, and selling those dollars forward for euros to repay the original loan. CIP expresses the potential for arbitrage to align borrowing costs and investment returns in integrated money and foreign exchange markets. d) Show graphically a drop in the interest rate paid by euro deposits. What is the effect on the dollar? (7 marks) The principle of covered interest parity (CIP), set out by Keynes (1923) during the floating exchange rate period after WWI, is a fundamental building block of international finance. Absent counterparty risk, CIP is a pure no-arbitrage relationship that equates the premium of a currency's forward over its spot exchange rate (both rates expressed as the price of foreign currency) to its nominal interest-rate advantage over foreign currency. Under CIP, for example, for those comparing two ways effectively to borrow US dollars, the US dollar interest rate equals the total cost of borrowing euros, buying dollars in the spot foreign exchange market, and selling those dollars forward for euros to repay the original loan. CIP expresses the potential for arbitrage to align borrowing costs and investment returns in integrated money and foreign exchange markets. d) Show graphically a drop in the interest rate paid by euro deposits. What is the effect on the dollar? (7 marks)