Can anyone please explain the answer of the following question? At the beginning of the period, the exchange rate between Country A and Country B is 3 (quoted as A/B). The ratio of the prices of the consumption basket in Country A to Country B is 2. During the year, Country A has inflation of 10 percent and Country B has inflation of 0 percent. At the end of the year, the exchange rate is 3.5. What is the end-of-period real exchange rate? A) 1.59. B) 1.00. C) 1.50. D) 0.45.
I get A. 1.59 Real exchange rate = spot * Foreign price level/Domestic price level (remember foreign price goes on top) at the end of the year: price level in country B after 0 inflation remains 1, country A price level after 10% inflation is 2.2. so 1/2.2 = .45455 end of year real exchange rate: 3.5 * .45455 = 1.59% I hope i’m right. am i?
A/B = 2/1 Inflation after 1 year A/B = [2*(1.10)]/[1*(1.00)] A/B = 2.2/1 (1 + R) = (1+N)/ (1 + E(Infl)) = (3.5)/(2.2) =1.59 = A?
1.59
Delta Real Rate = Delta Spot Rate - Delta Inflation (all quoted DC/FC, Delta Inflation = Inflation DC - Inflation FC) Begin Real Rate = Spot * Foreign / Domestic Price Index = 3 * 1/2 = 1.5 Delta Inflation = 10% - 0% = 10% Delta Spot = (3.5-3)/3 = 16.67% So Delta Real Rate = 16.67% - 10% = 6.67% As Begin Real = 1.5, Ending Real = 1.5 * (1 + 6.67%) = 1.59 A
A: 1.59