As a portfolio manager, you are considering investing in Invesco's CurrencyShares Euro Currency Trust (NYSE ticker: FXE), which tracks the U.S. dollar price of the euro. As part of your research, you learned that FXE has an average return of 0.55% per annum (prior to fees) since its inception in 2005. You also noticed the following macroeconomic data:

                                        Year     U.S. CPI   Euro Area CPI

                                       2005        191.60         83.20

                                       2020        261.56     105.15

1. Based on historical information provided above, is FXE overvalued, undervalued, or fairly valued if the Relative Purchasing Power Parity holds? Explain your answer.
2. Suppose you want to omit the global financial crisis from your analysis and determined that the relevant time window should be between 2015 and 2020. The average performance of FXE for the last five years is 1.56% per annum. If the CPI levels for the U.S. and Euro Area in 2015 are 237.761 and 100.03, respectively, is FXE overvalued, undervalued, or fairly valued if the Relative Purchasing Power Parity holds? Explain your answer.

Answer rating: 100% (QA)

Relative Purchasing Power Parity RPPP states that the exchange rate between two currencies should ad... View the full answer