Exchange rate movements Suppose a basket of goods in Pads costs €135 and the same basket purchased in New york costs $152 a) At what exchange rate between euros and dollars is the cost of the basket the same in each city

Finance Mar 08, 2021

Exchange rate movements Suppose a basket of goods in Pads costs €135 and the same basket purchased in New york costs $152

a) At what exchange rate between euros and dollars is the cost of the basket the same in each city. (Round to four decimal paces)

b) Now suppose that over the next year inflation in France is expected to be 2% while in the U.S. the forecast is for 5% inflalion. What exchange rate do you expect a year from now?
(Round to four decimal paces)

Expert Solution

a) Computation of the exchange rate between euro and dollars:-

Exchange rate = Cost of basket in Paris / Cost of basket in New York

= €135 / $152

= €0.8882/$

b) Computation of the exchange rate a year from now:-

Exchange rate a year from now = Exchange rate * (1 + Inflation rate in France) / (1 + Inflation rate in US)

= (€0.8882/$) * (1 + 2%) / (1 + 5%)

= €0.8628/$

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