Beruflich Dokumente
Kultur Dokumente
International
Parity
Conditions
International Parity Conditions:
Learning Objectives
P$ S = P
Where the price of the product in US dollars (P$), multiplied
by the spot exchange rate (S, yen per dollar), equals the
price of the product in Japanese yen (P)
P
S= $
P
If the Law of One Price were true for all goods, the
purchasing power parity (PPP) exchange rate
could be found from any set of prices
Through price comparison, prices of individual
products can be determined through the PPP
exchange rate
This is the absolute theory of purchasing power
parity
Absolute PPP states that the spot exchange rate is
determined by the relative prices of similar basket
of goods
$
C
E = E x FC
$
R
$
N
C
7-15 2012 Pearson Education, Inc. All rights reserved.
Exhibit 7.3 IMFs Real Effective Exchange
Rate Indexes for the United States, Japan,
and the Euro Area
P $
BMW = PBMW x S
/$
$
P $40,000
BMW, 2
$
= = 1.1429, or + 14.29%
P BMW, 1 $35,000
S1 S2
x 100 = i i
$
S2
FC 90
1 + i x 360
F FC/$
90 =S FC/$
x
$ 90
1 + i x 360
90
1 +
0.400 x
360
Sfr/$
F90 = Sfr1.4800 x
= Sfr1.4800 x
1.01
= Sfr1.4655/$
90 1.02
1 + 0.800 x
360
Rule of Thumb:
If the difference in interest rates is greater than
the forward premium (or expected change in
the spot rate), invest in the higher yielding
currency.
If the difference in interest rates is less than the
forward premium (or expected change in the
spot rate), invest in the lower yielding currency.