Suppose it is October 1,1990 and inflation rates in the U.S.and France are expected to be 4% and 9%,respectively,next year and 6% and 7%,respectively,in the following year.If the current spot rate is $.1050,then the expected spot value of the franc in two years is
A)$.1111
B)$.1024
C)$.0992
D)$.1074

Question

Quizplus · Accepted Answer

To calculate the expected spot value of the franc in two years, we need to use the following formula:

Expected Spot Rate = Spot Rate x (1 + Foreign Interest Rate) / (1 + Domestic Interest Rate)

For the first year, using the given inflation rates, we get:

Expected Spot Rate in 1 Year = .1050 x (1 + .09) / (1 + .04) = .11305

For the second year, using the new spot rate from the first year, we get:

Expected Spot Rate in 2 Years = .11305 x (1 + .07) / (1 + .06) = .09918

Rounding to four decimal places, we get the expected spot value of the franc in two years to be $.0992. Therefore, the best choice is C.

Suppose It Is October 1,1990 and Inflation Rates in the U.S.and