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Using the PPP theory on the price of beef in Great Britain & the United States

Two countries, Great Britain and the United States, produce just one good: beef. Suppose the price of beef in the U.S. is $2.80 per pound and in Britian it is £3.70 per pound. (PLEASE - Do not take this question unless you have provided detailed answers and reasoning for each part)

A) According to PPP theory, what should the $/£ spot exchange rate be?

B) Suppose the price of beef is expected to rise to $3.10 in the United States and to £4.65 in Britain. What should the one-year forward $/£ exchange rate be?

C) Given your answers to parts a and b, and given that the current interest rate in the United States is 10 percent, what would you expect the current interest rate to be in Britain?

Solution Preview

Two countries, Great Britain and the United States, produce just one good: beef. Suppose the price of beef in the U.S. is $2.80 per pound and in Britian it is £3.70 per pound. (PLEASE - Do not take this question unless you have provided detailed answers and reasoning for each part)

A) According to PPP theory, what should the $/£ spot exchange rate be?
According to PPP
$/£ spot exchnage rate = ...

Solution Summary

You will find the answer to this puzzling question inside.

$2.19