Question

Assume $1 is currently equal to A$1.1024 in the spot market. Also assume the expected inflation rate in Australia is 2.8 percent as compared to 3.4 percent in the U.S. What is the expected exchange rate one year from now if relative purchasing power parity exists?

a. A$1.0958
b. A$1.1005
c. A$1.875
d. A$1.985
e. A$1.0810

Answer 1

Answer:

a. A$1.0958

Explanation:

The calculation of expected exchange rate in one year from now is shown below:-

Expected rate in one year from now = Spot market × (1 + Expected inflation rate in Australia) ÷ (1 + Expected inflation rate in U.S.)

= A$1.1024 × 1.028 ÷ 1.034

= A$1.1024 × 0.9941

= A$1.0958

So, for computing the expected exchange rate in one year we simply applied the above formula.