Question

Your firm wants to convert $1.4 million Australian into US dollars in purchase in 12 months. The spot rate is $0.9704 equals $1 Australian. The inflation rates in Australia and the United States are expected to be 6 percent and 2 percent, respectively. Using the concept of purchasing power parity (PPP) as its relates to future exchange rates, determine the difference in costs between completing the transaction now and doing it in 12 months. A. $36,821 B. $54,320 C. $42.568 D. $60,242

Answer 1

The difference in costs between completing the transaction now and doing it in 12 months is $51,268.

Given Information

Australian dollars = $1,400,000    

Spot rate = 0.9704 USD per Australian Dollar  

Inflation in US - 2%

Inflation in Australia = 6%  

PPP expected rate = Spot rate * (1+inflation in US)/(1+inflation in Australia)

PPP expected rate = 0.9704 * (1+2%)/(1+6%)

PPP expected rate = 0.933781132

US amount with Spot rate = $1,400,000*0.9704

US amount with Spot rate = $1,358,560

US amount with forward rate = $1,400,000*0.93378

US amount with forward rate = 1,307,292

Differential US amount = US amount with Spot rate - US amount with forward rate

Differential US amount = $51,268

Therefore, the difference in costs between completing the transaction now and doing it in 12 months is $51,268.

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