Omni Advisors, an international pension fund manager, uses the concepts of purchasing power parity (PPP)

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QUESTION:

(CFA question) Omni Advisors, an international pension fund manager, uses the concepts of purchasing power parity (PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. Omni gathers the financial information as follows:

Base price level …………………………….….………. 100

Current U.S. price level ……………….…..………… 105

Current South African price level ……..…………. 111

Base rand spot exchange rate ……….….……. $0.175

Current rand spot exchange rate …….….…. $0.158

Expected annual U.S. inflation ……………….…… 7%

Expected annual South African inflation ………. 5%

Expected U.S. one-year interest rate ………..…. 10%

Expected South African one-year interest rate … 8%

Calculate the following exchange rates (ZAR and USD refer to the South African rand and U.S. dollar, respectively).

a. The current ZAR spot rate in USD that would have been forecast by PPP.

b. Using the IFE, the expected ZAR spot rate is USD one year from now.

c. Using PPP, the expected ZAR spot rate is USD four years from now.


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