Skip to content

IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates

According to the absolute version of purchasing power parity (PPP), the equilibrium exchange rate between the rupee and the US dollar is determined by which of the following?

Absolute PPP says the exchange rate equals the ratio of the price of the same basket of goods in the two countries. Arbitrage in goods markets is assumed to equalise prices once converted. Interest rate gaps, reserves and growth differences belong to other theories.

  1. AThe ratio of the price of an identical basket of goods in India to its price in the United StatesCorrect
  2. BThe difference between Indian and US nominal interest rates
  3. CThe size of India's current account deficit relative to GDP
  4. DThe ratio of foreign exchange reserves held by the two central banks
  5. The difference between the expected GDP growth rates of the two countries

Explanation

Absolute PPP is the law of one price applied to a whole basket: the exchange rate equals the ratio of the basket's price in one country to that in the other. Interest rate differentials relate to interest rate parity, not absolute PPP. Current account balances, reserves and growth rates are not what absolute PPP uses.

Did you get it right without looking?

One question tells you little. A timed set on Balance of payments and exchange rates shows your real accuracy, how long you take and where you lose marks.

Practise Balance of payments and exchange ratesFree diagnostic mock

More Balance of payments and exchange rates questions