1. These questions concern the choice to purchase a Euro financial asset, or a Japanese Yen financial asset. Both assets are 3 month maturity government bonds, of Germany and Japan, respectively. Suppose the interest rate on the yen asset is 0.02 and the interest rate on the euro asset 0.02. Today is January 1. Todays spot rate is 125 yen to the euro. The spot rate traders expect to prevail on March 31 is 130 yen to the euro.

1. As discussed in lecture, use the most complete formulation to compare the expected return on the euro and yen assets.
2. As discussed in lecture, use the approximation of return I developed in the lecture to compare the expected return on the euro and yen assets.
3. Using the numbers calculated in parts a and b of this question, discuss the merits and costs of using the approximation.
4. Given the values I listed above, is the foreign exchange market in equilibrium? Discuss.
5. Sketch the graphical representation of the Asset Model. Given the values I listed above, identify the rates of return of the euro and yen asset in terms of the domestic currency.
6. Using your sketch, if the market is in equilibrium, explain why your graph indicates an equilibrium. If the market is not in equilibrium, explain how the market would move to equilibrium.