Assume That Both the Law of One Price and the Expectations

question 40

Multiple Choice

Assume that both the law of one price and the expectations theory of forward rates hold. The spot rate for the Ruritanean doubloon is 0.455 doubloon/$, and the one-year forward rate is 0.476 doubloon/$. Suppose that next year's forecasted rate of inflation in Ruritania is now revised upward by 10 percent. How does this affect exchange rates?

• A)The current spot rate changes to 0.500 doubloon/$.
• B)The forward rate changes to 0.524 doubloon/$.
• C)Next year's expected spot rate changes to 0.501 doubloon/$.
• D)The forward rate changes to 0.501 doubloon/$.

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