Problem: Suppose the spot exchange rate is $2.00 per euro and that the annual interest rate on one-year government bond is 10 percent in the U.S. and 8 percent in Germany.
1. If you expect the spot price of the euro to be $2.00 in one year, where will you invest? Explain
2. In order for investors to be indifferent between the U.S. and German securities, what would the one-year forward rate for euros have to be?
3. Given the initial spot rate at $2.00 per euro, interest rates as given above, and the principle of arbitrage, would the euro be expected to appreciate or depreciate? Explain.