As of today,the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next three years in the U.S.is 2 percent and 3 percent in the euro zone.What spot exchange rate should prevail three years from now?

Question

Quizplus · Accepted Answer

The correct spot exchange rate can be calculated using the International Fisher Effect, which suggests that the currency of the country with a higher inflation rate will depreciate against the currency of the country with a lower inflation rate. The formula to calculate the expected future spot rate is S1 = S0 * (1 + i_foreign) / (1 + i_domestic), where S0 is the current spot rate, S1 is the future spot rate, i_foreign is the inflation rate in the foreign country, and i_domestic is the inflation rate in the domestic country. Plugging in the given values: S1 = 1.25 * (1 + 0.03)^3 / (1 + 0.02)^3 = 1.25 * 1.092727 / 1.061208 ≈ $1.2139.

As of Today,the Spot Exchange Rate Is €1