Dear All:
According to formular: X = S (PF/PD). and quoted as A/B, why 2.2 in the denominator as the below problem?
Thank you so much for your time
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% and Country B has inflation of 0%. At the end of the year, the exchange rate is 3.5. What is the end-of-period real exchange rate?
A) 1.00. B) 1.59. C) 1.50.
Your answer: B was correct!
The real exchange rate is calculated as: X = S (PF/PD). Using Country A as the home country, the end-of-period real exchange rate is: X = 3.5(1 / 2.2). The ratio of the price levels reflects the inflation rates in the two countries (1 × 1.0 = 1 for Country B; 2 × 1.1 = 2.2 for Country A).