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Answer: The Euro will appreciate by $0.0280 to EUR/USD $1.4280
With PPP, the currency of the country with the **higher inflation rate** tends to **depreciate**. Since U.S. inflation (4.0%) exceeds Eurozone inflation (2.0%) by 2.0%, the **USD depreciates** and the **EUR appreciates** by about 2.0%. Starting from EUR/USD $1.40: $1.40 \times 1.02 = $1.4280 So the euro appreciates to **EUR/USD $1.4280**, which corresponds to **C**.
Author: Manit Arora
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Question 1.2. The current spot exchange rate between the Euro and the U.S. dollar is EUR/USD $1.40 (base/quote). Relative inflation rates shift from parity such that the inflation rate in the Eurozone is 2.0%, but the inflation rate in the United States is 4.0%. According to purchasing power parity (PPP), what should be the impact on the exchange rate?
A
The Euro will depreciate by $0.0510 to EUR/USD $1.4510
B
The Euro will depreciate by $0.0510 to EUR/USD $1.3490
C
The Euro will appreciate by $0.0280 to EUR/USD $1.4280
D
The Euro will appreciate by $0.0280 to EUR/USD $1.3720
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