Chartered Financial Analyst Level 1

Chartered Financial Analyst Level 1

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An analyst gathers the following information:

  • Foreign inflation rate: 2%
  • Domestic inflation rate: 3%
  • Nominal appreciation of domestic currency against foreign currency: 6%

The real appreciation of the domestic currency against the foreign currency is closest to:

Explanation:

The correct answer is B (5%).

Explanation: The real exchange rate change is calculated using the formula: (1+Nominal Appreciation)×(1+Foreign Inflation)(1+Domestic Inflation)−1(1 + \text{Nominal Appreciation}) \times \frac{(1 + \text{Foreign Inflation})}{(1 + \text{Domestic Inflation})} - 1 Substituting the given values: (1+6%)×(1+2%)(1+3%)−1=1.06×1.021.03−1≈0.0497 or 5%(1 + 6\%) \times \frac{(1 + 2\%)}{(1 + 3\%)} - 1 = 1.06 \times \frac{1.02}{1.03} - 1 \approx 0.0497 \text{ or } 5\%

Alternatively, using the approximate formula: Nominal Appreciation+Foreign Inflation−Domestic Inflation=6%+2%−3%=5%\text{Nominal Appreciation} + \text{Foreign Inflation} - \text{Domestic Inflation} = 6\% + 2\% - 3\% = 5\%

Why not A or C?

  • A (4%) incorrectly applies the formula without adjusting for inflation rates properly.
  • C (7%) swaps the domestic and foreign inflation rates in the calculation, leading to an overestimation.
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