At the beginning of the year the exchange rate between the Brazilian real and the U.S. dollar was 2.2 reals per dollar. Over the year,Brazilian inflation was 12 percent and U.S. inflation was 4 percent. If purchasing power parity holds,at year-end the exchange rate should be approximately ________ dollars per real.

Question

Quizplus · Accepted Answer

Purchasing power parity suggests that the exchange rate should adjust to reflect inflation differentials. The formula is: New Exchange Rate = Old Exchange Rate * (1 + Inflation Rate of Foreign Country) / (1 + Inflation Rate of Domestic Country). Applying this: 2.2 * (1 + 0.12) / (1 + 0.04) = 2.2 * 1.12 / 1.04 = 2.3692 reals per dollar. To find dollars per real, take the reciprocal: 1 / 2.3692 ≈ 0.4182.

At the Beginning of the Year the Exchange Rate Between