Consider the foreign exchange market, where Ry and Rj respectively denote interest rates on US dollar deposit and Japanese yen deposit, and E and Eº respectively denote the exchange rate and the expected exchange rate (a rise in E means the depreciation of US dollar). (1) Find the interest parity condition. (2) Find the equilibrium exchange rate E*. (3) Show that the equilibrium exchange rate is decreasing in interest rate on US dollar deposit but is in- creasing in interest rate on Japanese yen and the expected exchange rate. (4) Consider a case where the exchange rate is fixed at some level Ê so that people believe that the ex- change rate never change in the future. Show that if Ry # Rj, then the foreign exchange market cannot be

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