Assume that the U.S. one-year interest rate is 3% and the one-year interest rate on Australian dollars is 6%. The U.S. expected annual inflation is 5%, while the Australian inflation is expected to be 7%. You have $100,000 to invest for one year and you believe that PPP holds. The spot exchange rate of an Australian dollar is $0.689. What will be the yield on your investment if you invest in the Australian market?

purchasing power parity overestimated the exchange rate change during the period under

the exchange rate adjusted rate of return on a foreign investment should be equal to the
interest rate on a local money market investment.

a. 2%
b. 3%
c. 6%
d. 4%


d. 4%