Question: Veritas Emerging Market Fund specializes in investing in emerging stock markets of the world. Mr. Henry Mobaus, an experienced hand in international investment and your boss, is currently interested in Turkish stock markets. He thinks that Turkey will eventually be invited to negotiate its membership in the European Union. If this happens, it will boost the stock prices in Turkey. But, at the same time, he is quite concerned with the volatile exchange rates of the Turkish currency. He would like to understand what drives the Turkish exchange rates. Since the inflation rate is much higher in Turkey than in the U.S., he thinks that the purchasing power parity may be holding at least to some extent. As a research assistant for him, you were assigned to check this out. In other words, you have to study and prepare a report on the following question: Does the purchasing power parity hold for the Turkish lira-U.S. dollar exchange rate? Among other things, Mr. Mobaus would like you to do the following:

a. Plot the past exchange rate changes against the differential inflation rates between

Turkey and the U.S. for the last four years.

b. Regress the rate of exchange rate changes on the inflation rate differential to estimate

the intercept and the slope coefficient, and interpret the regression results.

Data source: You may download the consumer price index data for the U.S. and Turkey from the following website: http://www.oecd.org/EN/statistics/0,,EN-statistics-0-nodirectorate-no-no-no-0,00.html , “hot file” (Excel format) . You may download the exchange rate data from the website: http://pacific.commerce.ubc.ca/xr/data.html.