Interest rate parity/purchasing power parity
Does interest rate parity imply that interest rates are the same in all countries? Why might purchasing power parity fail to hold?
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Interest rate parity deals with interest rates and exchange rates. Interest rate parity does not mean that the interest rates would be the same in all countries. What it implies is that the forward exchange rates would track the interest rate differentials between the countries. What this means is that in a country where interest rates are high relative to another country, the exchange ...
Solution Summary
The solution explains the the concepts of interest rate parity and purchasing power parity.
Interest Rate & Purchasing Power Parity
1. Interest Rate Parity
Six month T-bills have a nominal rate of 7%, while default free Japanese bonds that mature in 6 months have a nominal rate of 55%. In the spot exchange market, I yen equals $0.009. If interest rate parity holds, what is the 6 months forward exchange rate?.
2. Purchasing Power Parity:
A television set costs $500 in the United States. The same set costs 550 euros in France. If purchasing power parity holds, what is the spot exchange rate between the euro and the dollar?
3. Result of Exchange Rate Changes:
Early in September 1963, it took 246 Japanese yen to equal $1. More than 20 years later that exchange rate had fallen to 108 yen to $1. Assume the price of a Japanese were in direct relation to exchange rates.
a-Has the price, in dollars, of the automobile increased or decreased during the 20 years period because of changes in the exchange rate?
b-What would the dollar price of the car be, assuming the car's price changes only with exchange rates?
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