tailieunhanh - Lecture International financial management - Chapter 8: Relationships among inflation, interest rates and exchange rates

This chapter explain the purchasing power parity (PPP) theory and its implications for exchange rate changes, explain the International Fisher effect (IFE) theory and its implications for exchange rate changes, compare the PPP theory, the IFE theory, and the theory of interest rate parity (IRP), which was introduced in the previous chapter. | 1 1 2 8 Relationships among Inflation, Interest Rates and Exchange Rates Explain the purchasing power parity (PPP) theory and its implications for exchange rate changes Explain the International Fisher effect (IFE) theory and its implications for exchange rate changes Compare the PPP theory, the IFE theory, and the theory of interest rate parity (IRP), which was introduced in the previous chapter 2 Chapter Objectives 2 3 Purchasing Power Parity (PPP) Interpretations of Purchasing Power Parity Absolute Form of PPP: without international barriers, consumers shift their demand to wherever prices are lower. Prices of the same basket of products in two different countries should be equal when measured in common currency. The relative version of PPP is calculated as: S=P1/P2 Where: "S" represents exchange rate of currency 1 to currency 2 "P1" represents the cost of good "x" in currency 1 "P2" represents the cost of good "x" in currency 2 4 For example, a chocolate bar that sells for C$ in a Canadian city should cost US$ in a . city when the exchange rate between Canada and the . is USD/CDN. (Both chocolate bars cost US$.) Relative Form of PPP: Due to market imperfections, prices of the same basket of products in different countries will not necessarily be the same, but the rate of change in prices should be similar when measured in common currency 5 Rational Behind Relative PPP Theory Exchange rate adjustment is necessary for the relative purchasing power to be the same whether buying products locally or from another country. If the purchasing power is not equal, consumers will shift purchases to wherever products are cheaper until the purchasing power is equal. 6 Purchasing Power Parity Relationship between relative inflation rates (I) and the exchange rate (e). Simplified PPP relationship 7 Using PPP to Estimate Exchange Rate Effects The relative form of PPP can be used to estimate how an exchange rate will change in response to differential | 1 1 2 8 Relationships among Inflation, Interest Rates and Exchange Rates Explain the purchasing power parity (PPP) theory and its implications for exchange rate changes Explain the International Fisher effect (IFE) theory and its implications for exchange rate changes Compare the PPP theory, the IFE theory, and the theory of interest rate parity (IRP), which was introduced in the previous chapter 2 Chapter Objectives 2 3 Purchasing Power Parity (PPP) Interpretations of Purchasing Power Parity Absolute Form of PPP: without international barriers, consumers shift their demand to wherever prices are lower. Prices of the same basket of products in two different countries should be equal when measured in common currency. The relative version of PPP is calculated as: S=P1/P2 Where: "S" represents exchange rate of currency 1 to currency 2 "P1" represents the cost of good "x" in currency 1 "P2" represents the cost of good "x" in currency 2 4 For example, a chocolate bar that sells for .