PPP & IFE QUESTIONS

1. There are different forms of the theory of Purchasing Power Parity (PPP). What form is
considered “Law of one price”?
a. Arithmetic form
b. Relative form
c. Accounting form
d. Absolute form

2. Inflation in the US is 3% and inflation in Europe is 5%. From the US point of view, how will
the euro change if the PPP occurs?
a. Price increase 1.94%
b. 1.9% discount
c. 1.94% discount
d. 1.9% price increase

3. Which of the following is NOT a reason for the difference in PPP? a. Relative
income level, trade barriers.
b. Interest rate differentials, there are no substitutes for imports. c. Both a
and b are reasons for the difference
d. Neither a nor b are reasons for the difference.

4. Assume the one-year interest rate in Switzerland is 3% and in the US it is 4%. If the
international Fisher effect exists, how do you expect the Swiss franc to change?
a. 9.7% price increase
b. 9.7% discount
c. Price increase 0.97%
d. Discount 0.97%

5. Assume the one-year interest rate in the UK is 6% and in the US it is 4%. If the spot rate of the
British pound is $1.5807 and the international Fisher effect persists, what do you expect the
pound futures spot rate to be one year from now?
a. $1.5509
b. $1,6111
c. $1,5500
d. $1,6001
6. Which of the following statements is TRUE?
a. The International Fisher Effect (IFE) uses interest rates to predict forward rates. b.
The International Fisher Effect (IFE) uses interest rates to predict future spot rates. c.
Interest rate parity (IRP) uses interest rates to predict future spot rates. d. Purchasing
Power Parity (PPP) uses interest rates to predict future spot rates.

7. Assume annual inflation in the US is 3%, in Europe it is 6%, and the spot rate is €1=$1.3234.
Calculate the projected future spot rate for the next 3 years?
a. €1 = $1,2142
b. €1 = $1,4424
c. €1 = $1.3619
d. €1 = $1.2859

8. Assume the spot rate is ¥83.6950/$ and the one-year spot rate is forecast to be ¥85,4520/$. The
one-year interest rate in the US is 5%. What is the equivalent one-year interest rate in Japan if
IFE exists?
a. 11.89%
b. 2.1%
c. 7.2%
d. 1.67%

9. Purchasing power parity says that:

a. The cost of a haircut in Columbia is exactly the same as the cost of a haircut
in Hong Kong b. The rate of inflation is the same in all countries
c. The spot rate is an accurate predictor of the inflation rate
d. Neither is correct

10. Because of the integrated nature of capital markets, US and UK investors demand the same
real rate of return of 3%. Inflation is expected in the US 2% in the UK 5%. Calculate nominal
interest rates in the UK and US.
a. 3% in both countries
b. 8% in the UK and 5% in the US
c. 1% in the US and - 2% in the UK
d. -1% in the US and 2% in the UK

11. Because of the integrated nature of the capital markets, US and UK investors demand the
same real rate of return of 3%. Inflation is expected in the US 2% in the UK 5%. Current spot
rate £1.00 = $1.5820. Calculate the expected spot rate for the next year assuming the
international Fisher effect exists
a. £1.00 = $1.6295
b. £1.00 = $1,6272
c. £1.00 = $1.5381
d. All three statements above are incorrect

12. Due to the integrated nature of capital markets, US and UK investors require the same real
rate of return of 3%. Inflation is expected in the US 2% in the UK 5%. Current spot rate £1.00 =
$1,5750. Calculate the one-year forward rate assuming Interest Parity exists. a. £1.00 = $1.5313
b. £1.00 = $1,6200
c. £1.00 = $1.6223
d. £1.00 = $1,5750

13. The Fisher effect states that ___________ is composed of the required real rate of return and
an inflation premium.
a. nominal exchange rate
b. real exchange rate
c. nominal interest rate
d. adjusted dividends

14. Assume annual inflation rates in the US and Mexico are forecast at 4% and 8%, respectively,
for the coming years. If the current spot rate of the Mexican peso (MXN) is $0.0803, then the
best forecast for the future spot rate of the peso over the next 3 years would be: a. $0.0717
b. $0.0899
c. $0.0903
d. $0.1012

15. If inflation is expected to be 5% and the required real rate of return is 6%, according to the
Fisher effect, the nominal interest rate will equal
a. 1%
b. 11%
c. -1%
d. 6%

16. If inflation in the US and Hong Kong are forecast to be 4% and 7% annually, respectively. If
the current spot rate of Hong Kong dollars is US$0.1286; So the expected spot rate next year
is
a. $0.1337
b. $0.1376
c. $0.1323
d. $0.1250
17. If a country with a free-floating currency depreciated in terms of purchasing power parity, the
capital account would be almost
a. deficit or tendency to be in deficit
b. surplus or tendency to surplus
c. inflation is expected to increase
d. is a World Bank borrower

18. The Canadian dollar spot rate is $0.76 and the 180-day forward rate is $0.74. The difference
between these two rates means
a. inflation in the US in recent years is lower than in Canada
b. interest rates in Canada rise faster than in the US
c. prices in Canada are expected to rise faster than in the United States
d. the Canadian dollar's spot rate is expected to rise against the US dollar

19. Suppose the British pound depreciates from $1.25 to $1.00 at the end of the year. Inflation for
the year in the UK is 15% and in the US it is 5%. What is the real value by which the pound
appreciates or depreciates?
a. -12.38%
b. -20.71%
c. +2.39%
d. +1.46%

20. The absolute form of the PPP explains the possibility of market imperfections such as
transportation costs, tariffs and quotas
a. Right
b. False

21. The International Fisher Effect (IFE) uses interest rate differentials rather than inflation
differentials to explain changes in exchange rates over time. It is closely related to the PPP
theory because interest rates are often not correlated with inflation
a. Right
b. False

22. It is possible that purchasing power parity exists but the international Fisher effect does not
exist for the same time
a. Right
b. False
23. Unlike purchasing power parity, the short-run international Fisher effect a. Right
b. False

24. The International Fisher Effect (IFE) and interest rate parity (IRP) use interest rate
differentials to predict expected future spot rates
a. Right
b. False

25. A simple statistical test of purchasing power parity can be performed by applying regression
analysis to historical data on inflation and exchange rate differentials a
. Right
b. Wrong