Hey, I think q-bank might be mistaken on this PPP question… Why don’t they convert the spot to direct quote? Thoughts? Brian Kenny, CFA, is an economist for Borderless Fund and was instructed by his colleague, John Dolan to create a forecasted exchange rate at the end of two years, Kenny’s investment horizon for the country of Kenya. The current spot exchange rate is 90.772 Kenyan Shillings (KS) for one euro (EUR). Kenny calculates annual inflation rates of 13% for the next two years for Kenya and 11% for the Economic European Community. Assuming relative purchasing power parity (PPP) holds, the expected forward exchange rate at the end of two years is: A) 94.0725 KS/EUR. B) 92.4075 KS/EUR. C) 89.1654 KS/EUR. Correct Answer was A.
they dont need to go to direct… Here is the logic Spot of Kenya to Euro = 90.772… Inflation Kenya = 13%, Inflation Euro = 11% So you know now that the Kenya currency will depreciate compared to Euro, because its inflation in higher… the euro is stronger… So think intuitively, if kenyan currency will increases, will it go up or down? It will take more Kenyan currency to buy one euro, so answer choice C is eliminated. next just use your formula: 90.772 * (1.13/1.11) = 92.4075, which is B… but remember, the problem says 2 years (tricky tricky) so 90.772 * (1.13^2/1.11^2) = 94.0725 A