Task 1: Question 1: Exchange rate determination The UIRP assumes that investors would like to earn profits in terms of interest rates. Instead, we can assume that investors are less interested in interest payments (in particular if they hold the paper less than one year and thus do not get interest rate payments) but more on speculative profits by buying bonds cheap and selling them at a higher expected price. Due to the inverse relation between interest rate and bonds price, this would explain why investors are not so much looking at interest rates but at expected interest rate changes. In fact, we can denote the expected return from speculative investment into a bond as exp CP+Pt+1-Pt Tt = Pt where CP are the coupon payments, and thus the effective interest rate which is used in the UIRP is it = CP/pt. Develop a variant of the UIRP using rt, rt which explains changes of the exchange rate not only by interest rate differences but also on expected changes of interest rates