Question

Purchasing Power Parity

Spot rate = 5.1 HK/NZ, Tax rates in the Hong Kong and New Zealand are 15% and 25% respectively.

New Zealand annual statistics                       Hong Kong annual statistics

Interest rates   10%                                         Interest rates 8%

Inflation          2%                                           Inflation 6%

                                               

a. What is the best estimate of the future HK/NZ spot rate in 6 months using Purchasing Power Parity?

b. If in 6 months, the actual exchange rate turns out to be 5.1 HK/NZ, which currency has appreciated in real terms and why?

c. How would a Hong Kong exporter feel about that (in real terms)?

Answer 1

Use of Purchase power Parity ,

Forward exchange rate

Here, F = 5.1 * (1.06/1.02)^0.05 = 5.2 HK/NZ

Answer b) If actual exchange rate is 5.1 HK/NZ , indicate currency of HK has appreciated in real terms it is possible due to differential in real interest rate term net of tax in two country.

Answer c) Such situation provides advantage to exporters of the country , as they have to pay less amount in terms of domestic currency in future term.