ACCA Strategic Professional · Advanced Financial Management · Management of international trade and finance
Spot is USD 1.5000 per GBP 1. Expected inflation is 5% a year in the UK and 3% a year in the US. Using purchasing power parity, what is the expected spot rate in one year?
The expected spot rate is USD 1.4714 per GBP. Purchasing power parity scales the current rate by the ratio of US to UK inflation factors, 1.03 over 1.05, so sterling, with higher inflation, is expected to depreciate against the dollar.
- AUSD 1.4714Correct
- BUSD 1.5000
- CUSD 1.5291
- DUSD 1.4571
Explanation
Expected spot = 1.5000 x 1.03/1.05 = 1.4714. Higher UK inflation implies sterling weakens against the dollar. Using the inverted ratio gives 1.5291, which wrongly strengthens sterling.
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