Beruflich Dokumente
Kultur Dokumente
International
Parity Conditions
Learning Objectives
P$ S = 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
i = r + + r
S1 S2
x 100 i i
$ ¥
S2
FC 90
1 i x 360
F90FC/$ SFC/$ x
$ 90
1 i x 360
90
1 0.400x 360
Sfr/$
F90 Sfr1.4800x
Sfr1.4800x
1.01
Sfr1.4655/$
90 1.02
1 0.800x 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.