ACCA Strategic Professional · Advanced Financial Management · International investment and financing decisions
The spot rate is USD 1.2500 per GBP. Expected annual inflation is 4% in the United States and 2% in the United Kingdom. Using purchasing power parity, what is the expected spot rate (USD per GBP) in one year?
The expected spot rate is USD 1.2745 per GBP. Under purchasing power parity the currency with higher inflation weakens, so the spot rate is multiplied by the ratio of US to UK inflation factors, 1.04 divided by 1.02.
- A1.2745Correct
- B1.2255
- C1.2500
- D1.3000
Explanation
PPP: forecast = 1.2500 x (1.04/1.02) = 1.2500 x 1.019608 = 1.2745. Option 1.2255 inverts the inflation ratio. Higher US inflation means the USD depreciates, so USD per GBP rises.
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