Another Exam 2PM Q: Econ/PPP only, solution, compare, actual

Spongebob

Exam 2 # 112:
In this Q you have to find out what the future spot rate should be and then compare to the actual future spot rate to say if the Canadian $ appreciated or depreciated in real terms. So the way I did it was with PPP: $0.5 x (1.02/1.07) = $0.476. But the solution says to do $0.5 x (1-0.05) = $.475. I know that I’m being a stickler and it’s only one thousandth of a decimal point off, but I’m asking about the method used–iisn’t Schweser wrong? I feel like they’re using a “simplistic, rough estimate” or guess and my way (PPP) is correct. Does anyone remember this Q? Thanks.

DarienHacker

in first year, .35C bought one dollar.
in second year, .476C bought one dollar.
you needed more C to buy a dollar.
C got weaker.

Chuckrox

last minute question if anyone can help.
not really understanding the reasoning behind the answer. Nominal spot rate in one year is .350 C/$ and Future spot rate is 0.476
Doesn’t this mean C appreciated in real terms?
obviously not, but can someone explain to me why.

chunty

(1 + a) / (1 + b) is approximately equal to a-b when a and b are relatively small #s.
so you could do it either the long way as 1.02/1.07 or (1-0.05) and as you yourself have attested the number is not a whole lot different, in the final analysis.

SkipE99

ya but i didnt use nominal = real + inflation. i used PPP to find the theoretical spot rate in one year.

KungFuPanda

You got basically the same number and should have the same answer. It’s the same thing as nominal=real+inflation - this is technically not the right way as it should be nominal=(1+real)x(1+inflation)-1, but you would be off just a bit.