Question

24.

Assume the spot exchange rate is £.6229. The expected inflation rate in the U.K. is 3.8 percent and in the U.S. it is 2.9 percent. What is the expected exchange rate three years from now if relative purchasing power parity exists?

£.5391

£.6062

£.6399

£.6285

£.6233

Answer 1

Spot Exchange rate 1$ =					£ 0.62229
Expected inflation rate in the U.K. =				3.80%	or 0.038
Expected inflation rate in the U.S. =				2.90%	or 0.029
Forward rate 3 Years from now as per relative purchase power parity formula
Forward rate = spot rate * (1+ inflation of U.s.)^I / (1+inflation of U.K.)^i
	0.62229 * (1+0.029)^3   / (1+0.038)^3
	0.606243
So, Expected exchange rate 3 years from now is 1$ = £0.6062.