# parity question

John Smith is a U.S. bond portfolio manager. John is considering investing in aportfolio of canadian dollar-denominated bonds. The current nominal spot exchange rate between the U.S. and Canada is .65 USD/CAD. The price level of the typical consumption basket in the U.S. to the price level of the typical consupmtion baset in canada is .65 usd/cad . 1 year later the inflation rates have indeed been 5 percent for the U.S. and 3 percent for canada. however the canadian dollar has depreciaated with an exchange rate of .61 usd/cad at the end of year one. Assuming the real eschange rate is 1 at the beginnning of the year, the real exchange rate at the end of the year is approximately a) .96 b) .94 c) .92

0.92058608 = C?

…ignore…

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A?

and i don’t remember how to do this exactly, but i just went with if we went from .65 to .61, that’s a little over a 6% increase for team USA, but inflation being bigger in the US would say US is 1.03/1.05 at about 98%… so i took the 6 and change increase with the 2% inflation problemo and combined them for a basket at about .96USD/CAD. i can promise you this is not the right way to do it, but seeing as i couldn’t remember how to do it, this is how i got to some answer. probably not the right answer. how’d you get your # SG? or how the heck do you do these? i can’t remember. oh econ, so much i don’t remember.

.61 * IFC/IDC FC=CAD, DC=USD .61 * (1 * 1.03)/ (1.05 * .65) = .9206… IFC/IDC = price basket = 1/0.65 now update for Inflation… so 1.03 / (0.65 * 1.05) this is after I went wrong with the interest rate formula of rdc/rfc before and ending up with the .96 answer the first time… (hopefully by d-day this will stick. inflation goes up, currency depreciates, interest rate goes up - currency appreciates (more foreign investment - more demand)… hurting…

0.61*1.03/0.6825

add this to the list of econ things i need to review.

I could be wrong too. Let the official answer come out.

you are right… this was in the stalla workshop thingie last weekend…

I’ve never seen a question quite like this before…