Question

The inflation rate in Great Britain is expected to be 4% per year, and the inflation rate in Switzerland France is expected to be 6% per year. If the current spot rate is £1 = SF 12.50, what is the expected spot rate in two years? A) SF12.99 B) SF 10.25 C) SF 11.44 D) SF 8.50 E) None of the above

Answer 1

Answer:

The spot rate in two years time = SF 12.99

Explanation:

The purchasing power parity states that the relationship between the current and future spot rate between two currencies can be linked to the differences in the expected inflation rate between the currency.

This relationship can be expressed as follows:

S1=  So× (1 + hc)/(1 + hb)

So= Current spot rate, Hc- inflation rate in Switzerland, Inflation rate in Britain

Spot rate in a year's time

S1= 12.50, Hc=6%, Hc=4%

S1= 12.50× (1.06/1.04)

S1=12.74

Spot rate in two year's time

S1= 12.74× (1.06/1.04)

S1= 12.99

The spot rate in two years time = SF 12.99