PPP: CFAI Reading 16 Question 19a

Hi All,

Question aks what the expected FX rate should be if the inflation index in country A went from 100 to 150 and in country b went from 100 to 140.

I simply did 140/150 = .9333 x prior Spot rate to arrive at my revised FX-rate of 2.8.

The answer in the book is 2.7 based on a 10% difference in the inflation indecies. (50% country A, 40% country B). and therefore the revised spot rate is 3.00 * .9 = 2.7.

Been awhile since i’ve done the math on PPP but I thought the calc would have been 1+40% / 1 + 1 + 50% which would have arrived at the answer I calculated. Why are they using 10% to calculate the appreciatation of country B’s currency?

They’re using the approximation to the inflation differential; you’re using the actual calculation.

The upshot is that you’re correct and they’re not.

A little onservation, isn’t %Change Sf/d= % Change Inf Sf/d?

Thanks S2000 for confirming!

My pleasure.