1. Suppose that the rate of inflation in Japan is 2% in 2011. If the rate of inflation in Germany is 5% during 2011, by how much would the yen strengthen relative to the euro if relative PPP is satisfied during 2011?
2. One of your colleagues at Deutsche Bank thinks that the dollar is severely undervalued relative to the yen. He has calculated that the PPP exchange rate is ¥140 >$, whereas the current exchange rate is ¥105 >$. Because interest rates are 3% p.a. lower in Japan than in the United States, he thinks that this is a good time to speculate by borrowing yen and lending dollars. What do you think?