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CFA Level 2
Economics

Expected Exchange Rate Calculation Using PPP

Very Hard Currency Exchange Rates Parity Conditions

XYZ Corporation, a multinational firm, operates in both the United States and Japan. The current spot exchange rate between the yen and the dollar is 110 JPY/USD. The firm expects inflation rates to be 3% in the U.S. and 1% in Japan over the next year. Assuming the purchasing power parity (PPP) holds, what is the expected exchange rate at the end of the year?

Using the relative PPP formula, the expected future exchange rate can be calculated by adjusting the spot rate for the differential in inflation between the two countries. The formula used is:

Expected Future Rate = Current Rate x (1 + Domestic Inflation Rate) / (1 + Foreign Inflation Rate)

With this context, calculate the expected exchange rate to determine which of the following statements is true.

Hint

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