Question

If inflation in the U.S. is projected at 3% annually for the next 5years and at 7% annually in Turkey for the same time period, and Lira/Dollar spot rate (L/$) is currently equal to 5.6702 then the exact relative PPP value of the spot rate (L/$) five years from now is given by:

Answer 1

Answer:

6.86011 Turkish liras per US dollar

Explanation:

US's inflation 3% for the next 3 years

Turkey's inflation 7% for the next 3 years

current Lira/Dollar spot rate (L/$) = 5.6702 (liras per dollar)

• inflation rate US = (1 + 0.03)⁵ = 1.159274
• inflation rate Turkey = (1 + 0.07)⁵ = 1.402552

difference = 1.402552 / 1.159274 = 1.20985 x current spot rate = 1.20985 x 5.6702 = 6.86011

Since the Turkish inflation rate is higher than the American inflation rate, then the Turkish lira will depreciate faster than the US dollar.