18 Drill Q 4 Suppose the current exchange rate for the Russian ruble is RUB 34.5

Question

18 Drill Q 4

Suppose the current exchange rate for the Russian ruble is RUB 34.52. The expected exchange rate in three years is RUB 37.76. Assume that the anticipated inflation rate is constant for both countries.(Enter your answer as directed, but do not round intermediate calculations.)

What is the difference in the annual inflation rates for the United States and Russia over this period? (Negative amount should be indicated by a minus sign. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

What is the difference in the annual inflation rates for the United States and Russia over this period? (Negative amount should be indicated by a minus sign. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Using the relative purchasing power parity equation:

Ft = S0 × [1 + (hFC – hUS)]t

So,

RUB 37.76 = RUB 34.52[1 + (hFC – hUS)]3

hFC – hUS = (RUB 37.76/RUB 34.52)1/3 – 1

hFC – hUS = - 0.97 or -97%

Therefore, Difference in the annual inflation rate of -0.97%

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