January 1, 1985, the annual inflation rates in the U.S. and France were expected to be 4% and 6%, respectively. If the current spot rate that day was $.1250, then the expected spot rate in two years was
A) $.1299
B) $.1150
C) $.1203
D) $.1335

Question

Quizplus · Accepted Answer

The expected inflation differential between the U.S. and France is 6% - 4% = 2%. Therefore, we would expect the French franc to depreciate 2% per year against the U.S. dollar. After two years, the expected spot rate would be:
$.1250 × (1 - 2%)² = $.1203

January 1, 1985, the Annual Inflation Rates in the U