The rate of inflation in USA is likely to be 3% per annum and in India it is likely to be 6.5%. The current spot rate of US $ in India is Rs..43.40. Find the expected rate of US $ in India after one year and 3 years from now using purchasing power parity theory.
Solution
According to Purchasing Power Parity theory
F/S = 1 + iA / 1 + iB
Where F = Forward Rate
S = Spot Rate
iA = Rs.inflation Rate and
iB = $ Inflation Rate
After 1 Year
F/42.40 = 1+0.065/1+0.03 therefore F = Rs. 44,8751
After 3 Years
F = 42.40 x 1.065/1.03 x 1.065/1.03 x 1.065/1.03 = Rs.47.9762
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