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CA Final · Integrated Business Solutions (Multidisciplinary Case Study with Strategic Management) · Advanced Financial Management

Case: Meridian Pharma Ltd, Hyderabad, has a UK subsidiary. In India, expected inflation is 6% p.a. and in the UK 2% p.a. Spot is Rs 105.00/GBP. Under purchasing power parity, what is the expected spot rate after 2 years (to the nearest paise)? Select the correct option.

Purchasing power parity says the rupee depreciates by the inflation differential. Expected spot after two years is 105 x (1.06/1.02)^2, which is about Rs 113.40 per pound. Simply adding the 4% differential or leaving the rate unchanged would be wrong.

  1. ARs 105.00
  2. BRs 113.40
  3. CRs 109.20
  4. DRs 113.38Correct

Explanation

Expected rate = 105 x (1.06/1.02)^2. 1.06/1.02 = 1.039216; squared = 1.079970. 105 x 1.079970 = 113.397, i.e. about Rs 113.40. Using the compounding check 105 x 1.1236 = 117.98 /1.0404 = 113.40. So the closest correct figure is Rs 113.40.

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