EXCHANGE RATE THEORIES

EDINSON DELGADO MARTINEZ

PPP THEORY
 PPP THEORY
• Purchasing Power Parity (PPP) is an economic theory that compares
different countries' currencies through a market "basket of goods"
approach. According to this concept, two currencies are in
equilibrium or at par when a market basket of goods (taking into
account the exchange rate) is priced the same in both countries.

• Investopedia https://www.investopedia.com/updates/purchasing-
power-parity-ppp/#ixzz5ALNpcuv3
PPP THEORY AND THE AMOUNT OF DATA: 3
YEARS
EXAMPLE OF A PPP
PPP FORMULA
 INTERNATIONAL FISHER EFFECT
• The international Fisher effect (IFE) is an economic theory that states that the expected change
between the exchange rate of two currencies is roughly equal to their countries' nominal interest
rates.

• The IFE provides for the assumption that countries with lower interest rates will likely also
experience lower levels of inflation, which can result in increases in the real value of the
associated currency when compared to other nations. By contrast, nations with higher interest
rates will experience depreciation in the value of their currency.

https://www.investopedia.com/terms/i/ife.asp#ixzz5ALUMwR3Z
INTERNATIONAL FISHER EFFECT EXAMPLE
INTERNATIONAL FISHER EFFECT EXAMPLE
 INTEREST RATE PARITY THEORY
• Interest rate parity is a theory in which the interest rate differential
between two countries is equal to the differential between the forward
exchange rate and the spot exchange rate. Interest rate parity plays an
essential role in foreign exchange markets, connecting interest rates, spot
exchange rates and foreign exchange rates.

Forward Rate = Spot Rate X (1 + Interest Rate of Domestic country)

(1 + Interest Rate of Overseas country)

https://www.investopedia.com/terms/i/interestrateparity.asp#ixzz5ALfej4ei
 Calculating the percent change in exchange
rates
• If a year ago the dollar-euro exchange rate was $1.32 and is now
$1.31, then the change in the exchange dollar-euro exchange rate
(ER) is ???
INTEREST RATE PARITY THEORY EXAMPLE
• For example, RH(nominal domestic interest rate), RF(nominal foreign
interest rate), and St(spot exchange rate) are 1 percent, 1.12 percent,
and $1.32 per euro, the forward discount on euro is ???