Question

Assume the inflation rate in the U.S. is 1.39 percent. The spot rate for a foreign currency is 1.521 while the 1-year forward rate is 1.537. What is the approximate rate of inflation in the foreign country?

		2.20%
		2.28%
		2.36%
		2.44%
		2.52%

Answer 1

Inflation rate in the U.S.: 1.39%

Spot rate for a foreign currency: 1.521

1-year forward rate: 1.537.

We Know that as per Purchase Power Parity Theory;

Forward Rate of foreign Currency / Spot rate of foreign Currency = (1+ Inflation rate Foreign currency) / (1+Inflation rate home currency)

1.537 / 1.521 = (1+ Inflation rate Foreign currency) / (1+0.0139)

Hence,

1 + Inflation rate Foreign currency = 1.537*1.0139/1.521

1 + Inflation rate Foreign currency = 1.0244

Inflation rate Foreign currency = 1.0244 - 1

Inflation rate Foreign currency = 0.0244 or 2.44%

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