Assume that the export price of a Nissan XTerra from Osaka, Japan is ¥3,750,000. The exchange rate is ¥121.84/$. The forecast rate of inflation in the United States is 2.8% per year and is 0.6% in Japan.

Question

a. What is the export price of the XTerra at the beginning of the year expressed in US dollars?
b. Assuming purchasing power parity holds, what should the exchange rate be at the end of the year?
c. Assuming 100% pass-thru of exchange rate changes, what should be the dollar price of an XTerra at the end of the year?
d. Assuming 75% pass-thru of exchange rate changes, what should be the dollar price of an XTerra at the end of the year?

Answer 1

Initial spot exchange rate (¥/$) 110.60
Initial price of a Nissan Xterra (¥) 2,800,000
Expected US dollar inflation rate for the coming year 2.000%
Expected Japanese yen inflation rate for the coming year 0.000%
Desired rate of pass through by Nissan 70.000%

a. What was the export price for the XTerra at the beginning of the year?
Year-beginning price of an XTerra (¥) 2,800,000
Spot exchange rate (¥/$) 110.60
Year-beginning price of a XTerra ($) $25,316.46

b. What is the expected spot rate at the end of the year assuming PPP?
Initial spot rate (¥/$) 110.60
Expected US$ inflation 2.00%
Expected Japanese yen inflation 0.00%
Expected spot rate at end of year assuming PPP (¥/$) 108.43

c. Assuming complete pass through, what will the price be in US$ in one year?
Price of XTerra at beginning of year (¥) 2,800,000
Japanese yen inflation over the year 0.000%
Price of XTerra at end of year (¥) 2,800,000
Expected spot rate one year from now assuming PPP (¥/$) 108.43
Price of XTerra at end of year in ($) $25,822.78

d. Assuming partial pass through, what will the price be in US$ in one year?
Price of XTerra at end of year (¥) 2,800,000
Amount of expected exchange rate change, in percent (from PPP) 2.000%
Proportion of exchange rate change passed through by Nissan 70.000%
Proportional percentage change 1.400%
Effective exchange rate used by Nissan to price in US$ for end of year 109.073
Price of XTerra at end of year ($) $25,671