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Hi John,
Im confused by this statement.
If the dollar nominal interest rate is less than the euro nominal interest rate, interest rate parity indicates that the euro will depreciate against the dollar.
If the dollar inflation rate is less than the euro inflation rate, purchasing power parity indicates that the euro will appreciate against the dollarIn both the PPP and IRP formula counter is the one above and base is the one below. so dollar(counter) will always depreciate if its interest rate or inflation rate is higher than euro (home) ?
Regards,
FurqanHerd Co is based in a country whose currency is the dollar ($). The company expects to receive €1,500,000 in six
months’ time from Find Co, a foreign customer. The finance director of Herd Co is concerned that the euro (€) may
depreciate against the dollar before the foreign customer makes payment and she is looking at hedging the receipt.
Herd Co has in issue loan notes with a total nominal value of $4 million which can be redeemed in 10 years’ time. The
interest paid on the loan notes is at a variable rate linked to LIBOR. The finance director of Herd Co believes that interest
rates may increase in the near future.
The spot exchange rate is €1·543 per $1. The domestic short-term interest rate is 2% per year, while the foreign
short-term interest rate is 5% per year.
Which of the following statements support the finance director’s belief that the euro will depreciate against the
dollar?
(1) The dollar inflation rate is greater than the euro inflation rate
(2) The dollar nominal interest rate is less than the euro nominal interest rate
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2Your first post:
Whether inflation or interest, if the dollar rate is higher than the euro rate, then the $/€ exchange rate will be higher. This means the euro will buy more dollars and therefore the euro will have appreciated (or the dollar depreciated) as you have written 🙂
The examiners answer has a typing error (even though the choice of answers is correct) 🙂
Your second post:
Please do not type out past exam questions in full – they are copyright of the ACCA and it causes us problems if they are copies on the website. Just say which question in which exam and then I can find it 🙂
As you will know from the examiners answer, the answer is B. This is correct and complies with what you (and I) have written above.
(Incidentally I have uploaded lectures working through the whole of this exam – you can find them linked from this page:
https://opentuition.com/acca/fm/acca-fm-revision-lectures/ )
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