Answer:
(1) Exchange Rate in 1 year = HUF 209.90 / $ (2)Exchange Rate in 2 years = HUF 216.12 / $ (3)Exchange Rate in 5 years = HUF 235.92 / $
Explanation:
Solution
Given that:
The Spot Rate = HUF 203.86 /$
This implies that 1 dollar is equivalent to 203.86 Hungarian Forint
Now
(1) The exchange rate in one year
The Purchasing power parity equation is shown below:
Thus
E(S1) / S0 = (1 + RA) / (1 + RB)
Here
E(S1) = Expected Spot Rate of Year 1
S0 = Current Spot Rate - 203.86
RA = Inflation Rate in Hungary - 4.2%
RB = Inflation Rate in United States - 1.2%
Hence
The Exchange Rate in 1 year will be :
E(S1) / S0 = (1 + RA) / (1 + RB)
E(S1) / 203.86 = (1 + 0.042) / (1 + 0.012)
E(S1) / 203.86 = 1.042 / 1.012
E(S1) = (1.042 * 203.86) / 1.012
E(S1) = 209.90
Exchange Rate in 1 year is HUF 209.90 / $
(2)The exchange rate in 2 years
Thus
E(S2) / S1 = (1 + RA) / (1 + RB)
E(S2) = Expected Spot Rate of Year 2
S1 = Spot Rate of Year 1 - 209.90
RA = Inflation Rate in Hungary - 4.2%
RB = Inflation Rate in United States - 1.2%
Hence
The exchange rate in 2 years is HUF 216.12 / $
(3) Exchange Rate in 5 years
The first step here is to compute the expected spot rate of year 3 and year 4 respectively
So,
E(S3) / S2 = (1 + RA) / (1 + RB)
E(S3) = Expected Spot Rate of Year 3
S2 = Spot Rate of Year 2 - 216.12
RA = Inflation Rate in Hungary - 4.2%
RB = Inflation Rate in United States - 1.2%
E(S3) = (216.12 * 1.042) / 1.012
E(S3) = 222.53
E(S4) / S3 = (1 + RA) / (1 + RB)
Now
E(S4) = Expected Spot Rate of Year 4
S3 = Spot Rate of Year 3 - 222.53
RA = Inflation Rate in Hungary - 4.2%
RB = Inflation Rate in United States - 1.2%
E(S4) = (222.53 * 1.042) / 1.012
E(S4) = 229.13
Thus
The exchange rate in year 5 is given below:
E(S5) / S4 = (1 + RA) / (1 + RB)
E(S5) = Expected Spot Rate of Year 5
S4 = Spot Rate of Year 4 - 229.13
RA = Inflation Rate in Hungary - 4.2%
RB = Inflation Rate in United States - 1.2%?
E(S5) = (229.13 * 1.042) / 1.012
E(S5) = 235.92
Therefore the exchange rate in 5 years is HUF 235.92 / $
