Absolute and relative purchasing power parity theorems

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Reference no: EM132059177

1. Use Absolute and Relative Purchasing Power Parity theorems and:

a) Suppose price of a basket of goods and services in the U.S. and U.K. are $34 and 17 Pounds in 2016, respectively. Calculate 2016 spot exchange rate between dollar and pound.

b) If inflation rate in the U.S. and U.K. in 2017 are two and 12 percent, respectively, calculate the spot exchange rate between dollar and pound for 2017.

2. Use the Interest Parity Theorem and calculate a one-year forward exchange rate between dollar and pound if interest rate in the U.S. and U.K. are three and six percent in 2017, respectively (Hint: use the spot rate in part 1.b for this question).

3. If you are told that the following is true;

Interest rate (2018) = Interest rate in 2017 + the rate of increase in prices in 2018 in each country.

Use Interest Rate Parity Theorem and calculate 1-year forward rate between dollar and pound in 2018. Assume prices are expected to increase in the U.S. and U.K. at 10 and four percent in 2018, respectively.

Reference no: EM132059177

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