In the spot market, $1 is currently equal to £.5725. The expected inﬂation rate in the U.K. is 3 percent and in Canada 4 percent. What is the expected exchange rate 3 years from now if relative
Purchasing power parity exists?

Question

Quizplus · Accepted Answer

The correct answer is A because the expected exchange rate 3 years from now is £.55550. This is because the expected inflation rate in the U.K. is 3 percent and in Canada 4 percent. This means that the pound is expected to depreciate against the Canadian dollar by 3 percent per year. Therefore, the expected exchange rate 3 years from now is £.5725 * (1 - 0.03)^3 = £.55550.

In the Spot Market, $1 Is Currently Equal to £