How PPP is a way of defining the equilibrium exchange rate.

  (a) Explain how PPP is a way of defining the equilibrium exchange rate. [5 marks] (b) Assess how you would construct an arbitrage portfolio for Miss Catalea. You must support your answer with appropriate calculations. [10 marks] (c) Regress the rate of exchange rate changes on the inflation rate differential to estimate the intercept and the slope coefficient. Provide interpretation of the regression results. [10 marks] (d) Based on your knowledge of the efficient market approach and hedging evaluate the statement that “changes in exchange rates affect the settlement of contracts, cash flows and the firm valuation.” And advice Miss Catalea about the possible implications for FEMKX.