Q50021 The rate of inflation in India is 8% per annum and in the U.S.A.

The rate of inflation in India is 8% per annum and in the U.S.A. it is 4%. The current spot rate for USD in India is Rs. 46. What will be the expected rate after 1 year and after 4 years applying the 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/46 = 1+0.08/ 1+0.04 therefore F = Rs. 47.769

After 4 Years

F = 46 x 1.08/1.04 x 1.08/1.04 x 1.08/1.04 x 1.08/1.04  = Rs.53.4958

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