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The three-month dollar interest rate in New York is 5.20% per annum. Alternatively, the three- month euro interest rate in Frankfort is 6.60% p.a.

The three-month dollar interest rate in New York is 5.20% per annum. Alternatively, the three- month euro

The three-month dollar interest rate in New York is 5.20% per annum. Alternatively, the three- month euro interest rate in Frankfort is 6.60% p.a. The current $/ spot exchange rate is $1.1320/. The euro three-month forward rate is quoted at $1.1380/. Assume that the real rate of interest in both the euro zone and the U.S. is 1.60% per annum; use the Fisher Effect (FE) to calculate the expected annualized three-month rates of inflation in the euro zone and the U.S. (Expressed as a % p.a. up to four decimal places). Use the results in question 4 above and the Relative Purchasing Power Parity (RPPP) relationship to estimate the expected three-month spot exchange rate of the dollars against the euro. What do you notice about the answers to questions 2,3, and 5? Are they what you expect? Why or why not?

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SOLUTION To calculate the expected annualized threemonth rates of inflation in the euro zone and the US we can use the Fisher Effect formula 1 r 1 i 1 ... blur-text-image

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