Module 11.2: Mark to Market Value, and Parity Conditions Quiz

Hi,

Please clarify why the expected exchange rate in 1 year = current spot rate x (.99) in the answer to this question:

If the relative form of the PPP holds, the expected exchange rate in one year is closest to:

A) $1.3378 per €.

B) $0.7463 per €.

C) $1.3647 per €.

ANSWER:

A) $1.3378 per €.

Since inflation in Europe is higher than the inflation in the U.S. by 1%, the Euro is expected to depreciate by 1% annually against the dollar.

The current spot rate is $(1/0.74) per Euro or $1.3513/€

Expected exchange rate in 1 year = 1.3513(0.99) = $1.3378/€ (LOS 11.e)

Question ID: 981298