Assume the spot market exchange rate for $1 is currently A$1.1904. The expected inflation rate is 3.3 percent in Australia compared to the U. S. rate of 2.8 percent. What is the expected exchange rate one year from now if relative purchasing power parity exists?
a. $1.1844
b. $1.2062
c. $1.1964
d. $1.2286

c. $1.1964

Explanation:

The Expected Rate is calculated as follows,

Expected Rate = ((1+ Australia inflation rate)/(1+ U.S inflation rate)) *spot rate

Plugging in the figures therefore we will have,

Expected Rate = ((1+0.033) / (1 + 0.028)) * 1.1904

Expected Rate = $1.1964

$1.1964 is the expected exchange rate one year from now if relative purchasing power parity exists.

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