Purchasing Power Parity If the current spot rate between the U.S.dollar and the Netherland Antilles guilder was $1 = 1.68 guilder,and if the inflation rate in the United States was 1 percent and in the Netherland Antilles it was 6 percent,then what would be the expected spot rate in one year?

Question

Quizplus · Accepted Answer

According to the purchasing power parity (PPP) theory, the exchange rate between two currencies adjusts to reflect changes in the price levels of the two countries. In this case, if the inflation rate is higher in the Netherland Antilles, the expected change in the exchange rate will be such that the guilder will depreciate relative to the US dollar.

The formula for estimating the expected spot rate based on PPP is:

Expected Spot Rate = (Current Spot Rate) x (1 + Home Country Inflation) / (1 + Foreign Country Inflation)

Plugging in the values, we get:

Expected Spot Rate = 1.68 x (1 + 0.01) / (1 + 0.06) = 1.68 x 1.01 / 1.06 = 1.5953

Rounding to four decimal places, the expected spot rate in one year would be $1 = 1.5953 guilders or approximately $0.5654 per guilder (Option B).

Purchasing Power Parity If the Current Spot Rate Between the U.S.dollar