The table below shows the information for exchange rates, interest rates and inflation rates in the US and Germany. Answer the following questions

Current spot rate:$1.30/

One-year forward rate:$1.28/

Interest rate in the US:3%

Interest rate in Germany:4%

Inflation rate in the US:2%

Inflation rate in Germany:2.5%

(a) Find the 1-year forward exchange rate in $ per that satisfies IRP from the perspective of a customer

that borrowed $1000 traded for at the spot and invested in Germany.

(b) There is one profitable arbitrage at these prices. How to conduct the covered interest arbitrage if you

can either borrow $1000 in the US or 1000 in Germany?What would be the profit?

(c) What factors might lead to persistent covered interest arbitrage opportunities among countries?

(d) A fund manager uses the concepts of purchasing power parity (PPP) to forecast spot exchange rates

using the financial information. Calculate the future euro spot rate in dollar after one year that would be

forecast by relative PPP.

(e) What could be the reasons for the deviation of PPP?