Question

The spot exchange for the British Pound is quoted as $1.6750/₤ in London on July 1, 2019.

1. A. If the exchange rate six months later is $1.8595/₤, what is the annualized rate of appreciation or depreciation of the dollar for the US investor? Remember, e = (S(t+1) - S(t))/S(t).
2. B. If the inflation rate between July 1 and January 1, 2020, is expected to be 8% in the U.S. and 4% in UK annualized, what is purchasing power parity rate expected in January 1, 2020.

Answer 1

1. the exchange rate increase from $1.6750 to $1.8595 per euro which means the value of dollar is depreciated.

Currency depreciation = [(Forward rate - spot rate) / Forward rate] * 12/6

Currency depreciation = [(1.8595 - 1.6750) / 1.8595] * 12/6

Currency depreciation = 0.09922 * 12/6

Currency depreciation = 19.84%

2. Purchasing parity rate = $1.6750 * (1 + 6 month US inflation rate) = 1 Euro * (1 + 6 month UK inflation Rate)

$1.6750 * (1 + 4%) = 1 Pound * (1 + 2%)

$1.7420 = 1.02 Pound

1 Pound = $1.7078

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