Hi all, I wonder whether I am going mad or there is a mistake on Schweser book 1 reading 19 Q8. Assume that the current spot rate of exchange btw USD and EUR is eur1.2500 per USD. if the US inflation rate is expected to be 5% and the inflation rate in Europe is expected to be 4%, the expected spot rate of exchange three years from today is closest to: A. euro 1.2864 B. euro 1.2146 C. euro 1.2381 The answer is B according to Schweser. However, if the inflation in the US is expected to be higher than in Europe, USD is set to depreciate, and the expected spot rate EUR:USD should be higher than the current 1.2500, which is not the case for answer B. My calculation is : 1.2500 x [(1+1.05^3)/(1+1.04^3)]=1.2864 The answer should be A. Do you agree or have I misunderstood something? Is there an errata reproting somewhere we can check? Thanks
You have done it wrong. There is no errata It should be 1.25 x [(1.04)^3/(1.05)^3]
Thanks idreesz. When it says the exchange rate is “eur1.2500 per USD”, it is EUR:USD = 1.25, hence the base currency should be USD, therefore the numerator should be the US inflation rate. Am I right? Correct me if I am wrong. I find the whole session quite confusing.
suny Wrote: ------------------------------------------------------- > Thanks idreesz. When it says the exchange rate is > “eur1.2500 per USD”, it is EUR:USD = 1.25, hence > the base currency should be USD, therefore the > numerator should be the US inflation rate. Am I > right? Correct me if I am wrong. I find the whole > session quite confusing. No it should be: USD:EUR = 1.25 which is, Euro 1.25 / $ and that is why you take the numerator as EU inflation rate and denominator as US inflation rate.
mentally translate the : sign to “In” , e.g. USD In Euros . Even tho it takes a full 15 seconds to sink in( for me at least) , it makes it easier to picture that the asset is USD while the currency of the trade is Euros ( the “In” part ). Now if the asset is falling in price due to higher inflation , the rates paid are decreasing , so you cannot go for the answer that is higher . You can only choose B or C . That also gives you the correct choice of denominator and numerator to make it work