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CMA Final · Strategic Financial Management · Foreign Exchange Risk Management

An Indian firm has a USD receivable. Spot is Rs 80.00/USD. Annual inflation expected is 6% in India and 2% in the US. Under relative purchasing power parity (one-year), what is the expected spot rate after one year, approximately using the exact ratio?

Under relative purchasing power parity the expected spot equals the current rate times the ratio of Indian to US price levels, 80 x 1.06 / 1.02, which is about Rs 83.14 per dollar.

  1. ARs 83.14Correct
  2. BRs 84.80
  3. CRs 80.00
  4. DRs 83.20

Explanation

Expected spot = 80 x 1.06/1.02 = 80 x 1.039216 = Rs 83.14. Adding the inflation difference simply (80 x 1.04 = 83.20) is the approximation mistake. Rs 84.80 uses only Indian inflation.

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