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Estimate the spot exchange rates in terms of aud

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Question - After the graduation, you expect to become a foreign exchange dealer. Your curiosity about the behaviour of foreign exchange markets encourages you to conduct research on purchasing power parity theory. Your research outcomes in relation to gold and foreign exchange market are as follows:

Country

AUD

China

Price of Gold Oz   as at 1st October 2019

AUD1,715.52

CNY8,768.19

Predicted price-level changes in the six-month period started at 1st October 2019

1.23%

2.80%

Spot exchange rate as at 1st October 2019

AUD0.1912/CNY

Spot exchange rate as at 31st March 2020

AUD0.1840/CNY

Required -

1. Given prices of gold and the absolute purchasing power parity theory (APPP), estimate the spot exchange rates in terms of AUD for CNY as at 1st October 2019.

2. Does the CNY undervalue or overvalue against AUD? (Use your answer for (a) above and the exchange rate given as at 1st October 2019). What is the percentage change of overvaluation or undervaluation?

3. How can you explain the possible impact of the current overvaluation or undervaluation of CNY on the future value of CNY in AUD?

4. If relative purchasing power parity theory holds during that period, what would be the spot exchange rate as at 31stMarch 2020 in terms of AUD to CNY? (Use given actual spot rates as at 1st October 2019 and the annual inflation rates.

5. During the 6-month period, did the CNY appreciate or depreciate in real terms against the AUD? If so, what is the percentage change in value?

6. Briefly explain the concept of "foreign exchange pass through" how it is connected with the purchasing power parity theory.

Reference no: EM133183852

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