Problem
A. The UK inflation rate is predicted to be 10% and the Eurozone inflation rate is predicted to be 6%. The current euro per pound exchange rate is E1.20/81. What is the forecast E/f rate in one year's time according to Purchasing Power Parity? Is the euro expected to appreciate or depreciate and by approximately what percentage? (Show your working in full)
B. The euro per pound spot rate is E1.20/f1. The UK interest rate is 4% and the Eurozone interest rate is 6%. Calculate the six-month forward rate using the covered interest parity formula. State if the pound is at a forward discount or at a forward premium. (Show your working in full)