The current spot rate between the U.K. and the U.S. is £0.6789 per $1. The expected inflation rate in the U.S. is 2.1 percent. The expected inflation rate in the U.K. is 2.6 percent. If relative purchasing power parity exists, what will the exchange rate be next year?

Question

Quizplus · Accepted Answer

According to relative purchasing power parity theory, the exchange rate should adjust to equalize the price levels of two countries. Thus, the expected exchange rate can be calculated using the formula:

Expected exchange rate = Current exchange rate * (1+ Inflation rate in home country) / (1 + Inflation rate in foreign country)

= £0.6789 per $1 * (1+ 0.026) / (1 + 0.021)

= £0.6823 per $1

Therefore, the correct answer is C) £0.6823/$1.

The Current Spot Rate Between the U