The inflation rates in the U.S. and France are expected to be 4% per annum and 7% per annum, respectively. If the current spot rate is $.1050, then the expected spot rate in three years is

Question

Quizplus · Accepted Answer

According to the purchasing power parity theory, the expected change in the spot rate between two countries is equal to the difference in their inflation rates. Therefore, the expected spot rate in three years can be calculated as follows:

Expected spot rate = Current spot rate x (1 + inflation rate of the foreign country) / (1 + inflation rate of the domestic country) ^ number of years

Expected spot rate = $.1050 x (1 + 0.07) / (1 + 0.04) ^ 3
Expected spot rate = $.1050 x 1.07 / 1.125 ^ 3
Expected spot rate = $.1050 x 1.07 / 1.259
Expected spot rate = $.089175
Rounding up to the nearest cent, the expected spot rate in three years is $.0964, which is option C.

The Inflation Rates in the U