Answer: The expected exchange rate where interest parity holds is approximately $0.9237 = 1 euro.
Explanation: To find the expected exchange rate where interest parity holds, we can use the interest rate parity equation:
(1 + i${USD}$) = (1 + i${EUR}$) * (E${euro/USD}$ / E${euro/USD}$)
Where:
i${USD}$ = annual rate of return on dollar deposits = 3%
i${EUR}$ = rate of return on euro deposits = 1%
E$_{euro/USD}$ = current exchange rate = $0.9 = 1 euro
Plugging in the values, we have:
(1 + 0.03) = (1 + 0.01) * (E$_{euro/USD}$ / $0.9)
Simplifying the equation:
1.03 = 1.01 * (E$_{euro/USD}$ / $0.9)
Dividing both sides by 1.01 and multiplying by $0.9:
E$_{euro/USD}$ = 1.03 * $0.9 / 1.01
E$_{euro/USD}$ = 0.9237