Question

Suppose that the rate of inflation in the United Kingdom is 0.8%, and the rate of inflation in Canada is 5.2%. If the CAD appreciates relative to the GBP by 1.7% in real terms, then which of the following would be closest to the magnitude of the nominal appreciation (+) or depreciation (−) of the CAD? a. +2.59% b. −2.55% c. −2.70% d. +6.14% e. −5.81%

Answer 1

1.7% is the real return of appreciation of CAD. This implied that inflation of UK would have been considered to calculate real return of 1.7%. In order to find nominal rate in CAD terms, we need to reduce inflation off UK and then add back inflation in real return then found.

Therefore, real return net off inflation from UK = RealReturn/InflationOfUK = 1.017/1.008 -1 = .0089 or .89%

Nominal return of CAD = (1 + real return)*(1+inflation) -1

= 1.0089*1.052 -1 = 1.0614 -1 = 6.14%

Since, the CAD is appreciating, the nominal return is greater that real return, if inflation is positive. Therefore, nominal return will also be appreciating

Hence, the correct option is d +6.14%

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