ACCA Strategic Professional · Advanced Financial Management · Management of international trade and finance
The spot rate between the dollar ($) and the euro (€) is $1.2000 per €1. Expected inflation is 5% a year in the US and 2% a year in the eurozone. Using purchasing power parity, what is the expected spot rate ($ per €1) in one year?
The expected spot rate is $1.2353 per euro. Under purchasing power parity the rate moves by the ratio of inflation factors, 1.05 divided by 1.02, applied to 1.2000. Higher US inflation makes the dollar depreciate against the euro.
- A$1.1667
- B$1.2353Correct
- C$1.2706
- D$1.1765
Explanation
PPP: S1 = S0 x (1+ih)/(1+if) = 1.2000 x 1.05/1.02 = 1.2353. Option 1.1765 inverts the inflation ratio (1.02/1.05 x 1.2). The higher US inflation means the dollar weakens, so more dollars per euro.
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