Assume $1 is currently equal to A$1.2924 in the spot market. Also assume the expected inflation rate in Australia is 2.8 percent as compared to 2.4 percent in the U.S. What is the expected exchange rate one year from now if relative purchasing power parity exists?

Question

Quizplus · Accepted Answer

According to relative purchasing power parity:

Expected exchange rate = Spot exchange rate × (1 + inflation rate of home country) ÷ (1 + inflation rate of foreign country)
Expected exchange rate = A$1.2924 × (1 + 2.8%) ÷ (1 + 2.4%)
Expected exchange rate = A$1.2976

Assume $1 Is Currently Equal to A$1