Problem: An international pension fund manager uses the concepts of purchasing power parity (PPP) and the international fisher effect (IFE) to forecast spot exchange rates. The pension manager gathers the financial information as follows.
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BASE PRICE LEVEL
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100
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CURRENT U.S. PRICE LEVEL
|
105
|
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CURRENT SOUTH AFRICAN PRICE LEVEL
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111
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BASE RAND SPOT EXCHANGE RATE
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$.175
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CURRENT RAND SPOT EXCHANGE RATE
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$.158
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EXPECTED ANNUAL U.S. INFLATION RATE
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7%
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EXPECTED ANNUAL SOUTH AFRICAN INFLATION
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5%
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EXPECTED U.S. ONE YEAR INTEREST RATE
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10%
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EXPECTED SOUTH AFRICAN ONE YEAR INTEREST RATE
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8%
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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 IFE the expected ZAR spot rate in USD one year from now.
c. Using PPP the expected ZAR spot rate in USD four years from now.