What is the rate of return on a USD500,000 investment when the price level in the US is USD19,440, the price level in the UK is GBP13,784 and the spot rate is USD1.38/GBP?

Question 7Answer

a.

2.511%

b.

None of the options in this question are correct.

c.

2.139%

d.

3.052%

e.

2.198%

To determine the rate of return on the investment, we can use the **Purchasing Power Parity (PPP)** approach and the given spot exchange rate.

### Step 1: Determine the real exchange rate.
The real exchange rate can be calculated by comparing the price levels in the US and the UK, adjusted by the nominal exchange rate. The formula is:

\[
\text{Real Exchange Rate} = \frac{\text{Nominal Exchange Rate} \times \text{Price Level in UK}}{\text{Price Level in US}}
\]

Where:
- **Nominal Exchange Rate** (USD/GBP) = 1.38
- **Price Level in the UK** = GBP 13,784
- **Price Level in the US** = USD 19,440

\[
\text{Real Exchange Rate} = \frac{1.38 \times 13,784}{19,440} = \frac{19,019.92}{19,440} \approx 0.9783
\]

### Step 2: Calculate the rate of return.
The rate of return based on the real exchange rate can be approximated by subtracting 1 from the real exchange rate value and converting it to a percentage:

\[
\text{Rate of Return} = (0.9783 - 1) \times 100 = -0.0217 \times 100 = -2.17\%
\]

Since this is a **negative real rate of return** (indicating a loss), none of the options exactly match this. However, **option (b)** seems to be the closest and most accurate answer.

### Correct Answer:  
**b. None of the options in this question are correct.**

Would you like more details on how exchange rates affect returns, or any clarifications?

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Here are 5 related questions to further your understanding:
1. How is purchasing power parity (PPP) used in determining exchange rates?
2. What are the factors that influence the real exchange rate between two countries?
3. How do changes in inflation rates affect the rate of return on foreign investments?
4. Can the rate of return on investment be negative even with a positive nominal exchange rate?
5. What are the limitations of using PPP to determine investment returns?

**Tip:** Always check whether you are calculating the nominal or real return, as inflation and exchange rates can impact both differently!

What is the rate of return on a USD500,000 investment when the price level in the US is USD19,440, the price level in the UK is GBP13,784 and the spot rate is USD1.38/GBP?

Find out how to calculate the rate of return on a USD500,000 investment when given the price levels in the US and UK, and the spot exchange rate of USD1.38/GBP. This problem covers the use of Purchasing Power Parity (PPP) and the real exchange rate formula.

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