Question

At the beginning of the year the exchange rate between the Brazilian real and the U.S. dollar was 2.2 reals per dollar. Over the year, Brazilian inflation was 12 percent and U.S. inflation was 4 percent. If purchasing power parity holds, at year-end the exchange rate should be approximately ________________ dollars per real.

• 2.3913

• 0.4895

• 2.8498

• 0.4182

• 0.3440

Answer 1

Solution:-

Purchasing power parity provides relationship between spot,expected spot and inflation.

If a country has lower inflation than other,then the currency of that country should be appreciated.

Spot rate = U.S Dollar / Brazillian Real

= 1/2.2

= 0.454545

U.S Inflation = 4%

Brazil inflation = 12%

Inflation difference between two countries = 4% - 12% = -8% or -0.08

Expected spot rate = Spot rate + spot * inflation difference

= 0.454545 + 0.454545 * (-0.08)

= 0.454545 - 0.036363

= 0.418181

If the purchasing power parity holds,at year end the Expected rate should be 0.4182 dollars per real