Interest Rate Parity, Inflation and Purchasing Power Parity

 

Assume that the spot rate is €0.8144/$, the 180-day forward rate is €0.7933/$, and the 180-day dollar interest rate is 6 percent per year. What is the 180-day euro interest rate per year that would prevent arbitrage?
The consumer price index for the United States (U.S.) rose from approximately 121.4 in 1990 to approximately 199.3 in 2010.

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How much inflation was there in the U.S. during the twenty-year period?
What is the significance of the consumer price index to a multinational corporation?

If the price level in Canada is C$18,500, the price level in France is €13,095, and the spot exchange rate is C$1.25/€, please answer the following questions:

What is the internal purchasing power of the Canadian dollar? (Hint: it may be best to calculate the purchasing power of C$10,000 first and divide by the price level of C$18,500 to obtain the number of consumption bundles for C$18,500).
What is the internal purchasing power of the euro in France? (Hint: it may be best to calculate the purchasing power of €10,000 first and divide by the price level of €13,095 to obtain the number of consumption bundles for €13,095).
What is the implied exchange rate of C$/€ that satisfies absolute PPP?
Is the euro overvalued or undervalued relative to the Canadian dollar? Explain the reasoning for your answer.

Your answers must be presented in a Word document; if you do any calculations in Excel, copy and paste them from Excel into the Word document.  Make sure your responses are clearly marked so your instructor knows which questions your responses are answering.  Written comments must be formatted in conformity with the CSU-Global Guide to Writing and APA Requirements (Links to an external site.).
For numerical answers, briefly show or explain how you arrived at your solutions to get partial credit if one or more answers are incorrect.

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