Spot EUR/USD = .7224 Suppose an unanticipated increase in the money supply in the US causethe Us infation rate to increase to 5% in the nest 3 years In reaction to the money supply change, interest rates in the US immediately fall to 6%. assume the Eurozone interest rate is constant at 9.08%. using the asset market approach, the new equilbrum level of the EUR/USD spot rate is closest to: .6629 .7224 .7342 .7855
why is the answer not coming? have in gone all crazy in the middle of the night SR = 0.7224 EUR/USD So if the US infl increases by 5% the currency appreciates (using RPPP) new SR = 0.75852 EUR/USD —> E(S1) now using IRP for Long term equilibrium levels 0.75852/ (1.0908/1.06)^3 = 0.75852/1.0897272 = 0.69606 EUR/USD = nowhere?
simply eliminate the last 3 options since the Euro must appreciate. so option A
^^ dinesh… if US inflation goes up the USD will depreciate…so I would take 0.7224/1.05 = 0.688 following that I used the same calculations as you did… 0.688 * (1.06/1.0908)^3 = 0.6314 but that is still not an option! On the other hand Dsylexic has a good method…and it makes sense…except we’re assuming that the increase in the inflation rate of USD is higher than the inflation rate of EUR - which is not given in the question. if the EUR inflation was higher than USD - that logic wouldn’t work would it?
^^^Aren’t you interest rates flipped? I get your .688 and I also tried .7224(1-.05) = .68628 I try to divide both by (1.0908/1.06)^3 and neither gives me an answer. I thought I had this stuff on lock.
I get the same answer as mumukado. This is bothering me.
haha this is the market method I was talking about
I think Nibilita is right you need to have us dollar on top
are we sure we have all the info…? cause it says inflation increasing to 5% but it does not say the previous level???
I get same result as mumu
This is just like challenge problem 18 in reading 19 in Schweser. I had just done this last night because of what I read on this forum yesterday and I still can’t get it right. I hate all the foreign exchange econ and PM calculations, including this one. I did 1/.7224 to get 1.3843 /EUR. If inflation is 5% there will be 5% more /Euro so the spot rate in 3 years is 1.3843*1.05=1.4535 Using IRP, S*(1.06)^3=1.4535*(1.0908)^3 S=1.5842 /Eur 1/1.5842= .6312Eur/ Why isn’t that the answer? Isn’t this what Schweser did in their answer to an almost identical question?
It has to be a mistake!!
I’m getting .6314 also.
I still get .6314. The same answer I got this morning.