CA Final · Advanced Financial Management · International Financial Management
India's annual inflation is expected to be 6% and the United States' annual inflation 2%. The spot rate is Rs 80 per USD. Under relative purchasing power parity, what is the expected spot rate after one year (to the nearest paisa)?
The expected spot rate is Rs 83.14 per USD. Under relative purchasing power parity the rupee depreciates by the inflation ratio, so the spot is 80 multiplied by 1.06 divided by 1.02, giving about 83.14, since India has higher inflation than the United States.
- ARs 83.14Correct
- BRs 76.92
- CRs 84.80
- DRs 80.00
Explanation
Expected spot = 80 x (1.06/1.02) = 80 x 1.039216 = Rs 83.14. Rs 76.92 results from inverting the ratio (1.02/1.06), which is the wrong direction. Rs 84.80 comes from adding the 4% inflation differential to 80 as 80 x 1.06, ignoring US inflation.
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