The inflation rate in the U.S. is projected at 6% per year for the next several
ID: 2707790 • Letter: T
Question
The inflation rate in the U.S. is projected at 6% per year for the next several years. The Australian inflation rate is projected to be 2% during that time. The exchange rate is currently A$2.2. Based on relative PPP, what is the expected exchange rate in two years? Please show work.
The inflation rate in the U.S. is projected at 6% per year for the next several years. The Australian inflation rate is projected to be 2% during that time. The exchange rate is currently A$2.2. Based on relative PPP, what is the expected exchange rate in two years? Please show work.Explanation / Answer
For First Year,
PPP equation is 1 + id / 1+if = E(S) / S
1+0.02 / 1+0.06 = E(S) / 2.2 => E(S) = 1.02 x 2.2 / 1.06 = A$2.117
Second Year
1 + id / 1+if = E(S) / S
1+0.02 / 1+0.06 = E(S) / 2.117
=> E(S) = 1.02 x 2.117 / 1.06 = 2.037
Based on relative PPP, what is the expected exchange rate in two years = A$2.037
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