Turkey experienced hyperinflation in the late 1990s and early 2000s. The exchange rate for the Turkish lira was TRL 650,000 = $1 on January 1, 2000. In 2001, inflation in Turkey was 140%, while in the USA was only 2.5%. This led the Central Bank of Turkey to implement a mini-devaluation policy at a monthly rate of 7.5%. What was the official exchange rate on December 31, 2001? Was the Turkish lira properly valued? (Hint: Pay attention to the monthly devaluation process)

In 2006, a Big Mac cost ARS7.00 in Argentina and $3.10 in the United States. Three years later, in 2010, the same Big Mac cost ARS 14.00 in Argentina and $3.73 in the United States. Also, the actual exchange rate was ARS 3.06 = $1 in 2006 and ARS 3.93 = $1 in 2010. Assuming that the increase in the cost of the Big Mac is a reliable measure of price inflation in both countries, what should the PPP-implied exchange rate be in 2010?

c. Consider the spot exchange rate between the and the pound sterling = 1.50, while the annual forward exchange rate is = 1.60. The annual interest rate is 5.4% in Italy and 3 5.2% in the UK. Assume that you can borrow up to 1,000,000 or 666,667, at the current spot exchange rate.

i. Show how you can make profits from covered interest arbitrage. Consider you are an Italian investor. What is your profit?

ii. Explain how the interest rate parity will be restored as a result of covered arbitrage activities.

iii. Suppose you are a British investor. Show the covered arbitrage process and compute profits in terms of .