Question

Terry Lamoreaux has homes in both​ Sydney, Australia and​Phoenix, Arizona. He travels between the two cities at least twice a year. Because of his frequent trips he wants to buy some​ new, high quality luggage.​ He's done his research and has decided to go with a Briggs and Riley brand​ three-piece luggage set. There are retails stores in both Phoenix and Sydney. Terry was a finance major and wants to use purchasing power parity to determine if he is paying the same price no matter where he makes his purchase.

a. If the price of the​ 3-piece luggage set in Phoenix is ​$857 and the price of the same​ 3-piece set in Sydney is A $930​,using purchasing power​ parity, is the price of the luggage truly equal if the spot rate is

​A $1.0852​/$?

b. If the price of the luggage remains the same in Phoenix one year from​ now, determine what the price of the luggage should be in Sydney in​ one-year's time if PPP holds true. The U.S. Inflation rate is 1.14​%

and the Australian inflation rate is 3.18​%.

Answer 1

a) Yes, if the spot rate is AUD$1.0852/USD, the price would be equal

b) The price, one year from now of the luggage would be $948.76

Step-by-step explanation:

Hi, in order to verify if that spot rate provides the same value in Australian dollars, we just have to do as follows.

`Price(USD)=930AUD*(1USD)/(1.0852AUD)  =857`

So, yes, if the spot rate is AUD$1.0852/USD, the price would be the same.

For b. we have to look for the forward rate, in other words, the exchange rate one year from now, that is by using the following formula.

`F((AUD)/(USD) )=S((AUD)/(USD) )*((1+Inf(AUD))/(1+Inf(USD)) )`

That is:

`F((AUD)/(USD) )=1.0852((AUD)/(USD) )*((1+0.0318))/(1+0.0114)) )`

`F((AUD)/(USD) )=1.10707`

So, if the price in Phoenix still is $857, the price in Australia would be $857*1.10707 = $948.76

Best of luck