Question: Separated by more than 3,000 nautical miles and five time zones, money and foreign exchange markets in both London and New York are very efficient.

Separated by more than 3,000 nautical miles and five time zones, money and foreign exchange markets in both London and New York are very efficient. The following information has been collected from the respective areas:

Assumptions ___________London____________New York

Spot exchange rate ($/€)........1.3264.....................1.3264

1-year Treasury bill rate.......3.900%...........................4.500%

Expected inflation rate......Unknown....................1.250%

a. What do the financial markets suggest for inflation in Europe next year?

b. Estimate today's 1-year forward exchange rate between the dollar and the euro?

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