12. The relationship between the percentage change in the spot exchange rate over time and the differential between
comparable interest rates in different national capital markets is known as ________.

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13. Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.10% and a real rate of interest of 1.00%. Using
the Fisher Effect Equation, what is the approximate expected rate of inflation in the U.S. over the next year?

14. When Interest Rate Parity (IRP) does not hold

15. Suppose you observe a spot exchange rate of $1.50/
€
. If interest rates are 5% APR in the U.S. and 3% APR in the euro
zone, what is the no-arbitrage 1-year forward rate?
A.
€
1.5291/$
B. $1.5291/
€
C.
€
1.4714/$
D. $1.4714/
€

16. Suppose that the one-year interest rate is 5.0 percent in the United States; the spot exchange rate is $1.20/
€
; and the
one-year forward exchange rate is $1.16/
€
. What must one-year interest rate be in the euro zone to avoid arbitrage?

17. Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot
exchange rate is $1.12/
€
and the one-year forward exchange rate, is $1.16/
€
. Assume that an arbitrageur can borrow up to
$1,000,000.

18. Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, and that the spot
exchange rate is $1.60/
€
and the forward exchange rate, with one-year maturity, is $1.58/
€
. Assume that an arbitrager can
borrow up to $1,000,000 or
€
625,000. If an astute trader finds an arbitrage, what is the net cash flow in one year?

19. Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year
forward exchange rate is $1.16/
€
. What must the spot exchange rate be?
A. $1.1768/
€
B. $1.1434/
€
C. $1.12/
€
D. None of the above

20. A higher U.S. interest rate (
i
$
n
) will result in

21. Will an arbitrageur facing the following prices be able to make money?