Page 75 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management Rupesh Roshan Singh, Lovely Professional University

Notes Unit 5: Currency Forecasting

CONTENTS
Objectives
Introduction

5.1 Purchasing Power Parity (PPP)
5.1.1 Absolute Purchasing Power Parity
5.1.2 Relative Purchasing Power Parity

5.1.3 Graphic Analysis of Purchasing Power Parity
5.1.4 Empirical Testing of Purchasing Power Parity Theory
5.2 Interest Rate Parity (IRP)
5.2.1 Types of Interest Rate Parity (IRP)
5.3 International Fisher Effect (IFE)

5.4 Comparison of Purchasing Power Parity, International Fisher Effect and Interest
Rate Parity Theories
5.5 Summary

5.6 Keywords
5.7 Review Questions
5.8 Further Readings

Objectives

After studying this unit, you will be able to:

Explain the Purchasing Power Parity (PPP)
Describe the Interest Rate Parity (IRP)
Discuss the International Fisher Effect (IFE)
Explain the Comparison of Purchasing Power Parity, International Fisher Effect and Interest
Rate Parity Theories

Introduction

The phenomenon of exchange rates movement is an important issue in international finance
and managers of multinational firms, international investors, importers and exporters and
government officials attach enormous importance to it. In fact, they have to deal with the issue
of exchange rates every day. Yet, the determination of exchange rates remains something of a
mystery. Forecasters with the most impressive records frequently go wrong in their calculations
by substantial margins. However, many times poor forecasting is due to unforeseeable events.
For example, at the beginning of 1984, all forecasters uniformly predicted that the dollar would
decline against other major currencies. But the dollar proceeded to rise throughout the year
although in other respects the general performance of the world economy did not radically
depart from forecasts. This clearly shows that the theoretical models or other models used by

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