ACCA AFM · Guided practice (Show me how)
Chapter 22: Exchange Rate Determination
Exchange rate forecasting - purchasing power parity
Two exchange-rate cases. Rates are quoted as the first-named currency per one unit of the second. Purchasing power parity: S1 = S0 x (1 + hc) / (1 + hb), where c is the first-named currency (the one being counted) and b the second-named.
(a) The exchange rate is currently $/GBP 1.70 (dollars per pound). The inflation rate in the US is 5% p.a. and in the UK is 2% p.a. What will the exchange rate be in one year's time, and in two years' time? (Work to 2 decimal places.)
(b) The exchange rate is currently JPY/GBP 2,030 (yen per pound). The inflation rate in Japan is 4% p.a. and in the UK is 8% p.a. What will the exchange rate be in one year's time, and in two years' time? (Work to the nearest yen.)
(a) Dollars per pound
Calculate the forecast dollar-per-pound rates one and two years ahead.
(b) Yen per pound
Calculate the forecast yen-per-pound rates one and two years ahead.
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