An Australian Solar Panel manufacturer exports panels to India at a price of 5,000 Indian Rupee...

An Australian Solar Panel manufacturer exports panels to India at a price of 5,000 Indian Rupee (INR). Currently the exchange rate is AUD/INR50.11. The forecast rate of inflation in Australia is 2.8% per year and 3.9% per year in India. Use this data to answer the following questions on exchange rate pass-through. 1. What was the export price for the solar panel at the beginning of the year expressed in Australian dollars? 2. Assuming purchasing power parity holds, what should the exchange rate be at the end of the year? 3. Assuming 100% pass-through of exchange rate, what will be the dollar price of a solar panel at the end of the year? 4. Assuming 75% pass-through, what will be the dollar price of a solar panel at the end of the year?

Expert Solution

Initial spot exchange rate (INR/AUD) (s)	50.11
Initial price of solar panel (p) (in INR)	5,000
AUD inflation rate (Ia)	2.80%
INR inflation rate (In)	3.90%
Rate of pass through (Rp)	75.00%

Part (1) - Export price at the beginning of the year (AUD)
Beginning year price (in INR)	(p)	5,000
Spot exchange rate (INR/AUD)	(s)	50.11
Beginning year price (AUD)	(p/s)	99.78

Part (2) - Exchange rate at the end of the year (INR/AUD)
Spot exchange rate (INR/AUD)	(s)	50.11
Expected AUD inflation	(Ia)	2.80%
Expected INR inflation	(In)	3.90%
End of the year exchange rate (using PP)	S0 = s*(1+In)/(1+Ia)	48.75

Part (3) - Dollar price at the end of the year with 100% pass through
Price at the beginning of the year (INR)	(p)	5,000
INR inflation	(In)	3.90%
Price at the end of the year (INR)	P = p*(1+In)	5,195
End of the year exchange rate	(S0)	48.75
Price at the end of the year (AUD)	(P/S0)	106.57

Part (4) - Dollar price at the end of the year with 75% pass through
Price at the end of the year (INR)	P	5,195
Expected change in exchange rate	C = (s-S0)/S0	2.80%
Exchange rate pass through	Rp	75.00%
Proportionate change in exchange rate (%)	Pc = C*Rp	2.10%
Effective exchange rate (INR/AUD)	E = s/(1+Pc)	49.079
Price at the end of the year (AUD)	(P/E)	105.85

jeff jeffy answered 1 year ago

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