Question

(a) If a bottle of champagne costs €20 and the same bottle cost $30, what spot rate ($/€) establishes the Law of One Price (purchasing power parity) for these two commodities?

(b) If U.S. and euro expected inflation rates are 3% and 2% respectively, (a) what is the expected percentage change in the dollar rate? (b) what is the one-year forecast for the PPP rate, if the spot rate is the same as in part (a)?

Answer #1

_______________________________

_______________________________

Answer a)

Spot Rate = Cost of Chamagne on US / Cost of Chamagne on Europe

= 30 / 20

= 1.50

**1 Euro = $
1.50**

Answer b)

Forward Rate **=
**

**=
**

**=1.5147**

**Expected % change = 1% (approximately)**

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