Clarification: Intl Asset Pricing

This one is specifically for Schweser Exam 2, Afternoon Session (book 1), Question 111. Question asks if the real exchange rate at the end of the year was 1.41, GPB return on slapshots clients would be: a) 16.32% b) 17.37% c) 24.79% (Consumption basket pound/cad is 0.3, UK inflation 4%, Cad inflation is 7%, Spot rate Pound/CAD is 0.4) I chose C which is correct, but my calculations are off from the answer. can someone clarify if my steps are correct? What I did was take the real rate 1.41 to find the spot rate: 1.41 = Spot * (1/0.3) so Spot = 0.42 then find nominal rate using X = 0.42 (1.04/1.07) = 0.408 (0.408 - 0.400) / 0.400 = 0.02 so the return on the currency appreciation is 2% and on top of the 22% capital appreciation on the company’s stock i got 24% which is off by 0.79%. I have no clue what the schweser answer is saying so can someone kindly clarify? Thanks.

you are pretty much on the right line but remember that inflation affects the consumption basket. So calc it with the inflation adj basket as you are calculating for year end.

Hmmm… Investors care about REAL returns in their home currency so I always just compute the actual return (22%) and then find if the foreign currency apprecuiated or depreciated in REAL terms and add or subtract that to my base. I took the historical nominal spot (.4) and turned it into an expected real rate based on fisher (i think) real = .4*(1/.3)(1.07/1.04) = 1.3717 is the expected real exchange rate in a year If the actual rate was 1.41 (given), then in real terms the CAD appreciated by 2.79% the investor realizes return on the asset in whatever currency (22%) and they also get the gain or loss on the foreign currency. the CAD appreciated by 2.799% in real terms, so add um up for the 24.79%.

As long as you compare real to real or nominal to nominal, you should get the same answer.

I’m so confused in this part. So finding the “real spot rate” and multiplying it to (1 + Inf DC / 1 + Inf FC) doesn’t give you the same nominal spot rate as multiplying real exhange by (1 + Inf FC / 1 + Inf DC) and it’s related price basket… doesn’t make sense. but I guess I’ll swallow what I’m not familiar with.

BTW, what is the real exchange rate between Euro and Dollar these days. The nominal exchange rate is $1.23 / Euro as I write.