Capital markets expectations reading: practive prob 19A
[question removed by moderator] What should current exchange rate be if PPP prevails? Answer, inflation differential is 10% so according to PPP fip should appreciate against Swiss franc by same percentage. 0.9 x (3 fips per 1 CHF) = 2.7 fips per 1 CHF. Why are they using the exchange rate 10 years ago (3fips per 1CHF) and not the exchange rate now (2 fips per 1 CHF)?
The question is assuming the historical rate, and if PPP prevails, what should the rate be - if you use today’s rate, that is not addressing the question of should. You’d be applying an inflation differential to a rate that is likely already to be affected by inflation by some degree.
Because the question asks about what should the rate be assuming parity held, it has nothing to do with what actually happened.
Think about an extreme adverse FX rate change of 1000% from 3/1 to 30/1, in reality. Inflation differential of 10%. The question asks about what parity predicts the rate should be. Would you apply the 10% FIP appreciation to 30/1 that happened, or use the historical rate from when inflation was measured to figure out the implied FX rate? The latter.