Suppose that the US dollar interest rate and the Swiss Franc interest rate are the same, 5 percent per year, but that there is a risk premium of 1 percent associated with holding Swiss Franc rather than US dollars over the year.
(a) What is the relationship (in percentage terms) between the current equilibrium dollar/franc exchange rate and its expected future level?
(b) If the expected future exchange rate is $1.12 per franc, what is the equilibrium dollar/franc (spot) exchange rate? Now suppose that the expected future exchange rate, $1.12 US per franc, remains constant as Swiss’s interest rate rises to 10 percent per year.
(c) If the US interest rate also remains constant, what is the new equilibrium dollar/franc exchange rate?
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