In 2009, the interest rate on 20-year bonds was 2% (per year) on Switzerland\'s

Question

In 2009, the interest rate on 20-year bonds was 2% (per year) on Switzerland's government bonds and 3.5% on U.S. government bonds. Suppose the bonds for both countries were completely safe, the expected real interest rates were equal in both countries, and purchasing-power parity holds at every moment in the past, present, and future. Be as precise as you can and explain exactly what this difference in nominal interest rates (and these assumptions) implied about:
a. Expected changes in the U.S. real exchange rate vis-á-vis Switzerland:
b. Expected rates of inflation in the U.S. and Switzerland.
c. Expected changes in the U.S. nominal exchange rate vis-á-vis Switzerland

Explanation / Answer

In 2009, the interest rate on 20-year bonds was 2% (per year) on Switzerland's government bonds and 3.5% on U.S. government bonds. Suppose the bonds for both countries were completely safe, the expected real interest rates were equal in both countries, and purchasing-power parity holds at every moment in the past, present, and future. Be as precise as you can and explain exactly what this difference in nominal interest rates (and these assumptions) implied about:
a. Expected changes in the U.S. real exchange rate vis-á-vis Switzerland:
b. Expected rates of inflation in the U.S. and Switzerland.
c. Expected changes in the U.S. nominal exchange rate vis-á-vis Switzerland

It can be explained by the following relation.
Current interest rate = annual interest payment/ bond price.
if the demand for money increases people converts bonds into money this increases the supply of bonds decreasing the price of bonds, lower bond price will make the interest to rise.
Due to this higher interest rate in US there will be an increase in the deamnd for US dollars, this appreciateds the US currecny and the nominal exchange rate gets reduced with swiss frank.
As the niminal echange rate gets reduced real exchange rate will also decrease as the purchase power parity is constant.
Regarding inflation, in US as the interest rates are higher its inflation is comparatively lower than in that of Swizerlands.
Thus nominal exchange rate of Frank per dollar will decrease, this makes real exchange rate of Frank per dollar to decline as the purchasing power parity holds constant.
Higher interest rates resluts in lowering inflation, so US has a lower inflation comparable to Swizerland.

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