Question

You believe that the future value of the Australian dollar will be determined by purchasing power parity (PPP). You expect that inflation in Australia will be 6 percent next year, while inflation in the United States will be 1 percent next year. Today the spot rate of the Australian dollar is $0.78, and the one-year forward rate is $0.73. What is the expected spot rate of the Australian dollar in one year

Answer 1

The expected spot rate of the Australian dollar in one year = 1.28 AUD per USD

Step-by-step explanation:

The Current spot rate of Australian dollar against US Dollar

=
`(1)/(0.81)` AUD /USD

`= 1.234` AUD per USD.

Inflation rate in Australia
`= 6`%

Inflation in the US
`= 2`%

Percentage change in Australian currency

`=((1+0.06))/((1+0.02)) -1`

`=0.039 = 3.9` %

Thus, the spot exchange rate of AUD 1 year from now will be

`(1+0.039)*1.23 = 1.28`AUD per USD.