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 Relative PPP theory, the exchange rate should adjust to offset differences in inflation rates between countries. Since the U.S. inflation rate has been 4% higher than that in Canada, the U.S. dollar should have depreciated relative to the Canadian dollar by approximately 4%. This means that the current spot exchange rate should be $1.04/C$1, which is 4% higher than the original rate of $1/C$1. Therefore, the best choice is C.

One Year Ago the Spot Rate of U