The spot rate between the euro and the US dollar is €1.77/US$ and the expected annual rates of inflation are expected to be 2 per cent and 5 per cent respectively.
a. If the purchasing power parity theory holds, what will the spot rate of exchange be in one year?
b. If the interest rates available on government bonds are 6 per cent in the Eurozone and 9 percent in the USA, and the interest rate parity theory holds, what is the current one-year forward rate?