Assume the following information for Australia and the United States of America where AUD represents Australian dollar and USD represents US dollar.

AUSTRALIA UNITED STATES

Nominal Interest rate 1.50% 0.78%

Expected Inflation 1.30% 1.60%

Spot rate 1AUD = 0.7536 USD

One-year forward rate 1AUD = 0.7482 USD

a)Does IRP hold? Justify your answer with any appropriate calculations and explain.

b)According to the International Fischer Effect (IFE), what is the expected spot rate of the AUD in one-year?

c)Suppose that the price level in Canada is CAD 16,600, the price level in France is EUR 11,750, and the spot exchange rate is 1 EURO = 1.35 CAD i.e. EUR/CAD 1.35.

i.What is the implied exchange rate of EUR/CAD that satisfies absolute PPP?

ii. Is the euro overvalued or undervalued relative to the Canadian dollar?