Your curiosity about the behavior of foreign exchange markets encourages you to conduct a research project on

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Question:

Your curiosity about the behavior of foreign exchange markets encourages you to conduct a research project on purchasing power parity (PPP) theory. Your research in the gold market found that the price of one ounce of gold as at 1st September 2021 in Australia was AUD1,658.10 and in Malaysia was 4,933.38. In the same day, Malaysian ringgit were traded for AUD0.3239/MYR. You also found that the estimated inflation rate in Australia for the coming year was 2.30% and in Malaysia was 3.20%. You are required to

1. Estimate the spot exchange rate in terms of AUD for MYR as at 1st September 2021 using the given prices of gold and the absolute purchasing power parity (APPP) theory. (2 Points)

2. Is MYR undervalued or overvalued against AUD? Using your answer for (a) above and the exchange rate given as at 1st September 2021 estimate the percentage of overvaluation or undervaluation?(2 Points)

3. Explain the possible impact of the current overvaluation or undervaluation of MYR on the future value of MYR against the AUD? (1 Points)

4. Estimate the spot exchange rate as at 31st March 2022 (in 6-month) in terms of AUD to MYR using the actual spot rate as at 1st September 2021, annual inflation rates and relative PPP. (2 Points)

5. During the 6-month period, did the AUD appreciate or depreciate in terms of real value against the MYR if the actual spot rate as at 31st March 2022 wasAUD0.3205/MYR (hint: use the expected exchange rate in the part 4)? If so, what is the percentage change in value?(2 Points)

5. What do economist mean by the law of one price? Why might the law of one price be violated? Explain. (3 Points)