Assume the spot market exchange rate for $1 is currently A$1.2902.Also assume the expected inflation rate is 3.3 percent in Australia compared to the U.S.rate of 2.8 percent.What is the expected exchange rate one year from now if relative purchasing power parity exists?

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Quizplus · Accepted Answer

The expected exchange rate can be calculated using the formula for relative purchasing power parity (PPP): E(S1) = S0 * (1 + i_foreign) / (1 + i_domestic), where E(S1) is the expected exchange rate in one year, S0 is the current exchange rate, i_foreign is the inflation rate in the foreign country (Australia), and i_domestic is the inflation rate in the domestic country (U.S.). Plugging in the given values: E(S1) = 1.2902 * (1 + 0.033) / (1 + 0.028) = 1.2902 * 1.033 / 1.028 ≈ A$1.2967.

Assume the Spot Market Exchange Rate for $1 Is Currently