Suppose that, initially, the exchange rate of South African rands to US dollar S

Question

Suppose that, initially, the exchange rate of South African rands to US dollar S(ZAR/$) is at ZAR 5.26/$, and the inflation rate is 0.01 (i.e., 1%) per year in the US and 0.05 (i.e., 5%) per year in South Africa. You observe that the S(ZAR/$) exchange rate stands at a. ZAR 5.31/$ three months later, b. ZAR 5.37/$ half a year later, and c. ZAR 5.52/$ one year later. Did the relative purchasing power parity hold over the different horizons? (For this problem, please round the results of your calculations to 2 decimal places.)

Explanation / Answer

Formula: Sport rate x 1+Rq/1+Rb

(a) so 5.26x 1+(5x3/12)/100

1+(1x3/12)/100

= 5.31 ZAR

(b) so 5.26x 1+(5x6/12)/100

1+(1x6/12)/100

= 5.36 ZAR

(c) so 5.26x 1+(5x12/12)/100

1+(1x12/12)/100

= 5.47 ZAR

So there is difference in (b) and (c) Part

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