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Lecture Multinational financial management: Chapter 5 - Ngo Thi Ngoc Huyen

International parity conditions, arbitrage and the law of one price, law of one price, nominal and real exchange rates, nominal and real effective exchange rate indices as the main contents of the lecture chapter 5 "Parity condition in international finance & currency forecasting" drug lecture Multinational financial management. | CHAPTER FIVE PARITY CONDITION IN INTERNATIONAL FINANCE CURRENCY FORECASTING THE OF CHAPTER 5 Describes the core financial theories surrounding the determination of exchange More specifically four international parity conditions will be introduced among the exchanges rates price levels and interest rates Purchasing power parity Fisher effect International Fisher effect Interest rate parity Introduce the relationship between the future spot exchange rate and the forward exchange rate PARITY CONDITIONS Some fundamental questions that managers of MNEs international portfolio investors importers exporters and government officials must deal with every day are What are the determinants of exchange rates Are changes in exchange rates predictable The financial theories that link exchange rates price levels and interest rates together are called international parity conditions These theories do not always work out to be true when compared to what you observe in the real world but they are still fundamental to understand exchange rates and thus the risk of international investments Tire mistake is sometimes not with the theory itself but in the way it is interpreted or applied in practice RAG AND THE LAW OF ONE PRICE FIVE KEY THEORETICAL RELATIONSHIPS AMONG SPOT RATE FORWARD RATES INFLATION RATES AND INTEREST RATES 1 OF ONE PRICE If the identical product or service can be Sold in two different markets perfect substitutability of goods and services No restrictions exist on the sale free trade No transportation costs of moving the product between markets costless transportation St Then the product or service prices should be the same in both markets In a word perfectly tradable goods or services are subject to the law of one price A primary principle of competitively efficient markets is that prices of identical products or services will equalize across them if frictions or transportation costs do not exist OF ONE PRICE Example Price of wheat in France per bushel pe 3.45 Price