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Q. A fund manager uses the concepts of purchasing power parity (PPP) also the International Fisher Effect (IFE) to forecast spot exchange rates. He collects the financial information as follows:A yr ago, the spot rate between pound also dollar is $1.60/£. In the past yr, US inflation is 3.5percent (%) also UK inflation is 4.5percent (%). The current spot rate is $1.576/£.
a. Illustrate what is relative PPP? Compute the current pound spot rate in dollar which would have been forecast by PPP.
b. Does the PPP hold in this case? Illustrate what could be the reasons for which?
c. Illustrate what is IFE? If the expected US one-yr interest rate is 0.5percent (%), expected UK one-yr interest rate is 0.75percent (%), utilize IFE to predict the expected pound spot rate in dollar one yr from now.
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