The U.S. inflation rate is expected to be 3 percent over thenext year, while the...

The U.S. inflation rate is expected to be 3 percent over the next year, while the European inflation rate is expected to be 1.25 percent. The current spot rate of the euro is $1.19. Using purchasing power parity, the expected spot rate at the end of one year is $____.

		1.19
		1.20
		1.21
		1.22

Solutions

Expert Solution

Fwd rate :

Acc to PPPT,

Fwd rate = Spot rate * [ (1+Hi) / ( 1 + Fi) ]

Hi = Inflation rate in US
Fi = Inflation rate Europe

Particulars	Amount
Spot Rate	$ 1.1900
Hi	3.000%
Fi	1.250%
Home Country	US
Foreign Country	Europe
Forward rate for	1

According to Purchasing power parity Theorm,
Fwd rate After 1 Years = Spot rate * [ ( 1 + Hi ) ^ n ] / [ ( 1 + Fi ) ^ n ]
= $ 1.19 * [ ( 1 + 0.03) ^ 1 ] / [ ( 1 + 0.0125 ) ^ 1 ]
= $ 1.19 * [ ( 1.03) ^ 1 ] / [ ( 1.0125 ) ^ 1 ]
= $ 1.19 * [ 1.03 ] / [ 1.0125 ]
= $ 1.19 * [ 1.0173 ]
= $ 1.2106

Option C is correct

jeff jeffy answered 1 year ago

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