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IAI Actuarial Core Principles · Business Economics · Importance of international trade

Under purchasing power parity, India's annual inflation is 6% and US inflation is 2%. The spot rate is Rs 80 per dollar. Using the relative PPP approximation, what is the expected rupee rate per dollar after one year, rounded to the nearest rupee? (Use the exact ratio (1.06/1.02).)

The expected rate is about Rs 83 per dollar. Higher Indian inflation means the rupee should depreciate by the inflation ratio 1.06/1.02, so 80 × 1.0392 equals roughly 83.1. The rupee weakens, not strengthens, under relative purchasing power parity.

  1. ARs 76
  2. BRs 83Correct
  3. CRs 84
  4. DRs 80
  5. Rs 85

Explanation

Expected rate = 80 × 1.06/1.02 = 80 × 1.03922 = Rs 83.14, which rounds to Rs 83. Rs 84 uses the simple 4% difference on the spot (80 × 1.04 = 83.2, which also rounds to 83, but 84 mistakenly applies about 5%). Rs 76 reverses the direction of the inflation differential.

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