Question

You believe that the future value of the Australian dollar will be determined by purchasing power parity (PPP). You expect that inflation in Australia will be 6 percent next year, while inflation in the United States will be 1 percent next year. Today the spot rate of the Australian dollar is $0.78, and the one-year forward rate is $0.73. What is the expected spot rate of the Australian dollar in one year

Answer 1

Answer:

The expected spot rate of the Australian dollar in one year = 1.28 AUD per USD

Explanation:

The Current spot rate of Australian dollar against US Dollar

= $\frac{1}{0.81}$ AUD /USD

$= 1.234$ AUD per USD.

Inflation rate in Australia $= 6$%

Inflation in the US $= 2$%

Percentage change in Australian currency

$=\frac{(1+0.06)}{(1+0.02)} -1$

$=0.039 = 3.9$ %

Thus, the spot exchange rate of AUD 1 year from now will be

$(1+0.039)*1.23 = 1.28$AUD per USD.