Question

1)i) Use the following information to answer the next two questions.

A Japanese investor notices the expected one year inflation rate in Japan and Mexico is 7% and 5%, respectively. The current spot rates for yen and pesos are as follows:

$.14/MP, JY100/$What should be the value of pesos in terms of yen at the end of the year according to relative PPP? a).0728 b)13.3783 c).0701 d)14.266

ii)Suppose the spot rate at the end of the year is MP.065/JY. Has the yen appreciated or depreciated in real terms?a) appreciated b) depreciated c) neither d) insufficient info

iii)Assume a two-country world: Country A and Country B. Which of the following is as related to these two countries?

a) If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken in real terms according to relative PPP.
b)If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken in nominal terms according to relative PPP .
c)If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will strenghten in real terms according to relative PPP .
d)If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will strenghten in nominal terms according to relative PPP .

iV)A Canadian citizen observes that one year interest rates in Canada and Mexico are 12% and 8%, respectively. The current quotes for Canadian dollars and pesos are 1MP=.10USD and 1CD=1.05USD. What should be the value of pesos in terms of Canadian dollars according to the international Fisher effect?

a)10.1254

b).0988

c).0918

d)10.8887

Answer 1

1)i)Dollar to Peso = 0.14
Peso to Dollar = 1/0.14 = 7.1428
Yen to dollar = 100
Peso to YEN = 0.71428/100 = 0.071428
Value to Pesos to Yen After one year = Spot Rate*(1+inflation rate of Mexico)/(1+Inflation Rate Japan) = 0.071428*1.05/1.07
=0.0701

ii)The Yen has appreciated in Real terms because it is greater than 1 year rate according to PPP.

iii)Option b is correct option If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken in nominal terms according to relative PPP .

iv) PESOS to Canadian Dollar = 0.1/1.05 = 0.09524

Value of Peso in terms of Dollars = Spot Rate*(1+inflation rate of Mexico)/(1+Inflation Rate Canada)
= 0.09524*(1+8%)/(1+12%) = 0.09183

Please Discuss in case of Doubt

Best of Luck. God Bless
Please Rate Well