The current spot rate between the UK and the US is £0.5418 per US$1.The expected inflation rate in the US is 2.5 per cent.The expected inflation rate in the UK is 4.0 per cent.If relative purchasing power parity exists,the exchange rate 3 years from now will be:

Question

Quizplus · Accepted Answer

According to relative purchasing power parity, the exchange rate will adjust based on the inflation differential. The formula is: Future Exchange Rate = Current Exchange Rate * (1 + Inflation Rate of Foreign Country) / (1 + Inflation Rate of Domestic Country). Applying this: £0.5418 * (1 + 0.025)^3 / (1 + 0.04)^3 = £0.5665/$1.

The Current Spot Rate Between the UK and the US