BEC: Inflation and exchange rate

  • Creator
    Topic
  • #201455
    ppuran2
    Participant

    The U.S. inflation rate is expected to be 5% per annum while the Italian lira is expected to depreciate against the U.S. dollar by 10% during the same period. During the next year, an Italian firm importing from its U.S. parent can expect its lira cost for these imports to:

    A.

    decrease by about 5%.

    B.

    increase by about 5%.

    C.increase by about 15%.

    D.

    decrease by about 15%.

    correct answer is C. increase by 15% and why not B?

    I am confused because when US inflation causes US $ to depreciate by 5% and Italian Lira depreciated by 10% then

    shouldn’t the cost should go up by 5% option B.?

    Please help!

Viewing 12 replies - 1 through 12 (of 12 total)
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  • #772965
    Biff-1955-Tannen
    Participant

    “I am confused because when US inflation causes US $ to depreciate by 5% and Italian Lira depreciated by 10% then shouldn't the cost should go up by 5% option B.?”

    I think I see what you're saying there. I know other questions talk about how inflation and deflation will affect the demand for other countries currencies. (i.e. if the US dollar has 5% deflation, other countries will find it more attractive since they can purchase more for less)

    This questions isn't talking about how it is going to affect the demand for the currency, I would just think about this question as a transaction that is happening regardless. So with that being said, because the 5% inflation of the US dollar has the same effect as if the lira had a 15% Deflation.

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    #772966
    monikernc
    Participant

    US inflation will cause prices of US goods to rise 5%. At the same time the Lira will depreciate against the US$ by 10% which makes US goods bought with lira cost 10% more. the two combined cause the 15% increase in price for US goods purchased in Lira.

    the depreciation in Lira against the $ means they need 10% more Lira than they used to to buy $1 worth of US goods. coupled with the rise in prices by 5% caused by inflation in the US means the total cost of US goods purchased in lira will rise by 15%

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    #772967
    ppuran2
    Participant

    I do appreciate the responses. I am still confused, probably I have to change the approach to this question.

    #772968
    monikernc
    Participant

    reading this helped me to better grasp the concept:

    https://finance.zacks.com/appreciation-dollar-mean-10052.html

    AUD - 93
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    How have you been?
    Ninja book and MCQs and the forum, all first try! 2016
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    Experience was the worst part of the journey for me. You?
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    FAR 7/25/15 76!
    AUD 10/30/15 93
    BEC 2/27/16 82
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    Ninja Book and MCQ and the forum - all the way!!!
    and a little thing i like to call, time and effort!
    if you want things to change, you have to do something different

    #772969
    ppuran2
    Participant

    This is where i get confuse, lets say exchange rate is
    $1 = 100 Lira, 5% $ inflation would cause $ depreciation and exchange rate would go down and rate would be $1= 95 Lira and then with 10 % Lira depreciation it would be $1= 105. So Lira cost would go up by 5% in my understanding.
    Please help me understand where I am wrong in this logic, that would clear my confusion
    Thanks again!

    #772970
    monikernc
    Participant

    read the link i posted. it shows the price changes for each currency.

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    #772971
    Credit Revenue
    Participant

    The Lira is depreciating against the $ by 10% in that question. Therefore it is 10% less valuable and takes MORE Lira to buy the US goods. In this question 10% more. The price of goods in the US also went up 5%. So added together that is 15%. 5% inflation wouldn't change the exchange rate (in this question), but goods would simply cost 5% more. This is why it is giving approximate numbers. You are overthinking it. Inflation increases prices plus the Lira is weaker and Lira is the currency you are using.

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    #772972
    monikernc
    Participant

    start with $1 = 100 lira.
    5% US inflation means what cost a dollar now costs $1.05 so you need 5% more lira. $1.05 = 105 lira
    then, lira depreciates by 10%, so to buy $1.05 of US goods you have to spend 105 lira+ 10%more or 10.5 lira for a total of 115.5 lira which is a total increase of 15.5% lira

    AUD - 93
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    FAR - 76
    REG - 88
    How have you been?
    Ninja book and MCQs and the forum, all first try! 2016
    Licensed State of Montana April Fool’s Day 2020
    State of Colorado June 2020 - AICPA Ethics 93
    Experience was the worst part of the journey for me. You?
    If you want things to change you have to do something different.

    FAR 7/25/15 76!
    AUD 10/30/15 93
    BEC 2/27/16 82
    REG 5/23/16 88!
    Ninja Book and MCQ and the forum - all the way!!!
    and a little thing i like to call, time and effort!
    if you want things to change, you have to do something different

    #772973
    ppuran2
    Participant

    Okay got it!
    Thank you

    #772974
    monikernc
    Participant

    you're welcome

    AUD - 93
    BEC - 82
    FAR - 76
    REG - 88
    How have you been?
    Ninja book and MCQs and the forum, all first try! 2016
    Licensed State of Montana April Fool’s Day 2020
    State of Colorado June 2020 - AICPA Ethics 93
    Experience was the worst part of the journey for me. You?
    If you want things to change you have to do something different.

    FAR 7/25/15 76!
    AUD 10/30/15 93
    BEC 2/27/16 82
    REG 5/23/16 88!
    Ninja Book and MCQ and the forum - all the way!!!
    and a little thing i like to call, time and effort!
    if you want things to change, you have to do something different

    #772975
    cpa007
    Participant

    @monikernc
    Thanks for sharing this link , It was helpful.
    https://finance.zacks.com/appreciation-dollar-mean-10052.html#sthash.L5sB8KXo.dpuf

    Hope and determination will lead to success.
    #772976
    Credit Revenue
    Participant

    Monik – Will you look at the estate tax question I posted in the REG feed?

    A - 79 expires 4/30/16 need a pass on REG
    B - 78
    F - 80
    R - 83!!! Can live again!

Viewing 12 replies - 1 through 12 (of 12 total)
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