ExpertMedium2 marksMultiple Choice
ACCA · Question 14 · Risk Management
Section A
Andean Copper, based in Chile, exports to the USA. The current spot exchange rate is 800 CLP/USD (Chilean Pesos per US Dollar). Annual inflation is expected to be 5% in Chile and 2% in the USA.
According to Purchasing Power Parity (PPP), what is the expected spot exchange rate in one year's time? (Round to two decimal places)
Section A
Andean Copper, based in Chile, exports to the USA. The current spot exchange rate is 800 CLP/USD (Chilean Pesos per US Dollar). Annual inflation is expected to be 5% in Chile and 2% in the USA.
According to Purchasing Power Parity (PPP), what is the expected spot exchange rate in one year's time? (Round to two decimal places)
Answer options:
A.
777.14 CLP/USD
B.
800.00 CLP/USD
C.
823.53 CLP/USD
D.
824.00 CLP/USD
How to approach this question
Use the PPP formula: S1 = S0 × [(1 + hc) / (1 + hb)], where hc is the inflation rate of the quote/counter currency (CLP) and hb is the inflation rate of the base currency (USD).
Full Answer
C.823.53 CLP/USD✓ Correct
The Purchasing Power Parity formula is S1 = S0 × [(1 + hc) / (1 + hb)].
Here, USD is the base currency (1 USD = 800 CLP).
Chile inflation (hc) = 5% (0.05)
US inflation (hb) = 2% (0.02)
S1 = 800 × (1.05 / 1.02) = 800 × 1.02941 = 823.529 (rounded to 823.53 CLP/USD).
Common mistakes
Putting the base currency inflation in the numerator and the counter currency inflation in the denominator, resulting in 777.14.
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