Suppose Bob considers borrowing $100 from Sheila at a 10 percent interest rate. They both think that a 4 percent real interest rate would be fair.

a. What was the inflation rate they both expected? (3 marks)

b. If the inflation rate turned out to be 8 percent, how much was the real interest rate? Who gained and who lost from this transaction, and how much because of unexpected inflation? (4 marks)

c. If there was a capital gain tax of 30 percent, what is the after-tax real interest rate, with the inflation rate of 8 percent? (3 marks)

Suppose Canadian wheat sells for $100 per bushel and Russian wheat sells for 1600 rubles per bushel.

a. If you believe that the purchasing-power parity theory holds, and if the current exchange rate is 12 rubles per dollar, would you expect the exchange rate to change? In what direction? (3 marks)

b. If the current exchange rate is 12 rubles per dollar, how much is the real exchange rate, based on the prices of wheat? (3 marks)

c. If the exchange rate is 12, how you could make profit in this situation? How much profit per bushel you could make? (4 marks)

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