Suppose the year 1, year 2 and year 3 forecasts for the rate of inflation in Denmark are 3%, 4% and 5% respectively. Suppose also that the year 1, year 2 and year 3 forecasts for the rate of inflation in France are 11%, 9% and 8% respectively. If the expected spot rate between the Danish Krone (DKK) and the EUR is EUR0.1344/DKK at the end of year 3, what is the current spot rate?Question 9Answera.EUR0.119024/DKKb.EUR0.151762/DKKc.EUR0.128269/DKKd.EUR0.111027/DKKe.Not enough information to answer this question.
Question
Suppose the year 1, year 2 and year 3 forecasts for the rate of inflation in Denmark are 3%, 4% and 5% respectively. Suppose also that the year 1, year 2 and year 3 forecasts for the rate of inflation in France are 11%, 9% and 8% respectively. If the expected spot rate between the Danish Krone (DKK) and the EUR is EUR0.1344/DKK at the end of year 3, what is the current spot rate?Question 9Answera.EUR0.119024/DKKb.EUR0.151762/DKKc.EUR0.128269/DKKd.EUR0.111027/DKKe.Not enough information to answer this question.
Solution 1
To find the current spot rate, we can use the relative purchasing power parity (PPP) formula, which states that the change in the exchange rate is equal to the difference in inflation rates between the two countries.
Step 1: Calculate the total inflation for each country over the 3 years For Denmark: (1 + 0.03) * (1 + 0.04) * (1 + 0.05) = 1.1246 For France: (1 + 0.11) * (1 + 0.09) * (1 + 0.08) = 1.315392
Step 2: Calculate the ratio of the total inflation rates Ratio = Inflation Denmark / Inflation France = 1.1246 / 1.315392 = 0.855
Step 3: Multiply the expected spot rate at the end of year 3 by the ratio Current spot rate = Expected spot rate * Ratio = 0.1344 * 0.855 = 0.114912
Looking at the options provided, none of them exactly match the calculated value. However, option a. EUR0.119024/DKK is the closest to the calculated value.
Solution 2
To find the current spot rate, we need to use the formula for relative purchasing power parity (PPP). The formula is:
S0 = S3 / (1 + i_DK)^3 / (1 + i_FR)^3
where:
- S0 is the current spot rate
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