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An MNC, based in New York, wants to forecast the value of the euro to assist the Corporation in making some vital financial decisions. The following estimated model was produced by the research department of the firm. Et = 0.001 + 0.6 llt-1 - 0.7Rt where Et = % change in exchange rate for the euro

An MNC, based in New York, wants to forecast the value of the euro to assist the Corporation in making some vital financial decisions. The following estimated model was produced by the research department of the firm. Et = 0.001 + 0.6 llt-1 - 0.7Rt where Et = % change in exchange rate for the euro ll = inflation rate differential (US & France) R = real interest rate differential (US & France)

(a)Briefly comment on the appropriateness of the relationship suggested by the estimated parameters. (b)Suppose the firm developed a probability distribution for the variable with instantaneous impact as follows: Possible outcomes (%) -3 - 4 -5 Probability (%) 30 60 10 determine the probability distribution of the euros expected percentage change over the upcoming period assuming the lagged inflation rate deferential is 2%. (c)Based on the results in part (b), find expected value of the percentage change in the value of the euro and the forecast exchange rate given a spot rate of $1.05.

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