Spot exchange rate CHF 1.05/$ Swiss inflation rate (expected) p.a0.75% USA inflation rate (expected)* p.a2.25% a) Calculate

Spot exchange rate
 
CHF 1.05/$
Swiss inflation rate (expected)π p.a0.75%
USA inflation rate (expected)π* p.a2.25%
 
a) Calculate the expected future spot rate and the expected (ex ante) nominal rate of change in the exchange rate following the relative PPP over this one year period.  
 
b) At the end of one-year period, the actual inflation rate turned out to be the same as expected inflation rate in both countries. However, the actual (ex-post) nominal exchange rate turns out to be CHF1.02/$. What was the real rate of appreciation (or depreciation) of the base currency over this one-year period?
 
c) Based on your answers from (1) and (2), explain how the actual nominal rate of change deviates from the expected nominal rate of change can account for such deviations.

2) Suppose that the 90-day forward rate is $1.45/£, the current spot rate is $1.42/£, and you expect the future spot rate in 90 days to be $1.39/£. What contract would you make to speculate in the forward market by either buying or selling £1,000? What is your expected dollar profit?

Answer rating: 100% (QA)

a According to the Relative Purchasing Power Parity PPP theory the expected future spot rate is calculated as follows Expected Future Spot Rate Spot Rate x 1 Foreign Inflation Rate 1 Domestic Inflatio... View the full answer