M & B 4th Edition by Dean Croushore

Exercise 4

Suppose that the exchange rate adjusts so that interest-rate parity holds. Suppose also that the interest rate on a one-year German bond is 7 percent and the interest rate on a one-year U.S. bond is 4 percent.
a Suppose that you expect the exchange rate in one year to be 1.2 dollars per euro. What is the exchange rate today?
b Suppose that relative purchasing-power parity holds and that the infl ation rate in Germany is expected to be 2 percent over the next year. What is the expected infl ation rate in the United States?