Explanation:
Change in spot FX rate = Initial spot FX rate * (inflation_quote_currency - inflation_base_currency). In this case, Change in spot FX rate = EUR/USD $1.40 * (4% - 2%) = +$0.0280, such that new spot rate should be $1.40 + $0.028 = EUR/USD $1.4280; i.e., appreciation of the (base currency) Euro.
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Q-194.2. 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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