CFA Level I · CFA Level I Exam · Capital Flows and the FX Market
The real exchange rate between two currencies is best described as the nominal exchange rate:
The real exchange rate is the nominal exchange rate adjusted for the relative price levels in the two countries. It shows how many foreign goods a unit of domestic goods can buy, so it measures purchasing power rather than only the quoted currency price.
- Aadjusted for relative price levels in the two countries.Correct
- Bexpressed as the forward rate divided by the spot rate.
- Cadjusted for the interest rate differential between the two countries.
Explanation
The real exchange rate adjusts the nominal rate for the price levels of the two economies, so it measures the relative purchasing power of the currencies. The forward-to-spot ratio relates to interest rate parity, and interest rate differentials are not part of the real rate definition.
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