ACCA FM · Guided practice (Show me how)
Chapter 22: Forecasting foreign currency exchange rates
Exchange rate forecasting - purchasing power parity
Rates are quoted as the first-named currency per one unit of the second. Purchasing power parity (the notes' formula): 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, as the notes do.)
(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, rolling forward from the one-year rate.)
(a) Dollars per pound
Calculate the forecast dollar to pound exchange rates at the specified future year ends and identify which currency is expected to weaken.
(b) Yen per pound
Calculate the forecast yen to pound exchange rates at the specified future year ends and identify which currency is expected to weaken.
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