One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately

Question

Quizplus · Accepted Answer

According to the theory of Relative PPP, the exchange rate between two currencies should adjust to reflect changes in the inflation rates of the two countries. If the inflation rate in one country is higher than the other, then its currency should depreciate relative to the other currency to maintain purchasing power parity. In this case, since the inflation rate in the U.S. has been 4% higher than in Canada, the U.S. dollar should depreciate by 4% relative to the Canadian dollar. Thus, the new spot exchange rate should be $1/C$1.04, which is approximately $0.9615/C$1 or $0.96/C$1. Choice C) $1.04/C$1 is the closest option to this calculation.

One Year Ago the Spot Rate of U