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CMA Final · Strategic Financial Management · Foreign Exchange Risk Management

Over one year, India's inflation is 6% and US inflation is 2%. Spot is Rs 80.00/USD. According to relative purchasing power parity, the expected spot rate after one year is:

Relative PPP says expected spot equals current spot times the ratio of one plus Indian inflation to one plus US inflation: 80 x 1.06/1.02 = Rs 83.14. The rupee depreciates because Indian inflation is higher.

  1. ARs 83.14Correct
  2. BRs 76.92
  3. CRs 84.00
  4. DRs 80.00

Explanation

Expected spot = 80 x 1.06/1.02 = 83.137, about Rs 83.14. Rs 84 uses the simple inflation differential of 4% on the base, which ignores compounding. The inverted ratio gives 76.92.

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