ExpertMedium2 marksMultiple Choice
ACCA · Question 14 · Risk Management
Section A
The current spot exchange rate between the Euro (EUR) and the Brazilian Real (BRL) is EUR 1 = BRL 5.50.
Annual inflation is expected to be 2% in the Eurozone and 8% in Brazil.
According to Purchasing Power Parity (PPP), what is the expected spot rate in one year? (Round to two decimal places).
Section A
The current spot exchange rate between the Euro (EUR) and the Brazilian Real (BRL) is EUR 1 = BRL 5.50.
Annual inflation is expected to be 2% in the Eurozone and 8% in Brazil.
According to Purchasing Power Parity (PPP), what is the expected spot rate in one year? (Round to two decimal places).
Answer options:
A.
EUR 1 = BRL 5.19
B.
EUR 1 = BRL 5.50
C.
EUR 1 = BRL 5.82
D.
EUR 1 = BRL 6.05
How to approach this question
Use the PPP formula: S1 = S0 * [(1 + hc) / (1 + hb)], where hc is inflation in the counter currency (BRL) and hb is inflation in the base currency (EUR).
Full Answer
C.EUR 1 = BRL 5.82✓ Correct
Purchasing Power Parity links inflation differentials to expected exchange rate movements.
Formula: Expected Spot = Current Spot * (1 + Inflation of Quote Currency) / (1 + Inflation of Base Currency).
Expected Spot = 5.50 * (1.08 / 1.02) = 5.50 * 1.0588 = 5.823 (rounded to 5.82).
Common mistakes
Putting the base currency inflation in the numerator, which results in the wrong direction of currency movement.
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