10. Omni Advisors, an international pension fund manager, uses the concepts of purchasingpower parity (PPP) and uncovered interest parity/international Fisher effect (IFE) toforecast spot exchange rates. Omni gathers the financial information as follows:(Note: The rand (ZAR) is the South African currency. USD refers to the U.S. dollar.The base year denotes the beginning of the period.)
Base price level (any country)100
Current U.S. price level105
Current South African price level111
Base rand spot exchange rate$0.175
Current rand spot exchange rate$0.158
Expected annual U.S. inflation7%
Expected annual South African inflation5%
Expected U.S. one-year interest rate10%
Expected South African one-year interest rate8%
(a) According to PPP, what should the current ZAR spot rate in USD (USD/ZAR)be?
(b) According to PPP, is the U.S. dollar expected to appreciate or depreciate relativeto the rand over the year? Why?
(c) According to the UIP/IFE is the U.S. dollar expected to appreciate or depreciaterelative to the rand over the year? Why?
(d) Compare your answer in b) and c). Are you surprised? Why?