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Hello sir.
what if we are given both the inflation rate and interest rates of home and other country,which formula shall we use?
as i understood IRP is for Foward Exchange rates, Forward doesnt mean Future?
what PPP is for then?
If you are forecasting a future spot rate, then you use purchasing power parity.
If you are determining a forward exchange rate, then you use interest rate parity.
whats the difference between forecasting and determining future rates? i mean between future and forward?
2)Purchasing power relation=Exchange rates depend on Inlfation Rates (PPP formula)
Interest rate relation=Exchange rates depend on Interest Rates (IRP formula)Is there a formula that combines the relation of Exchange rate with both Inflation and Interest rates?
Forward rates and spot rates are two different things, as you will appreciate from the lectures.
Forward rates (quoted today to apply on a future date) are (in real life as well as in exams) calculated using interest rate parity.
Spot rates in the future are affected by lots of factors, but if you are asked to predict/forecast a future spot rate then we use purchasing power parity.
In a perfect world, interest rates and inflation rates go up and down together (as per the Fisher formula) and therefore interest rate parity and purchasing power parity would give the same result. But this is not combining the two together and is not the case in exam questions.
1)so the higher interest the higher inflation is and lower exchange rate is ?
2)If the spot rate now is, say: dollar to pound=1.5, it says exchange rate. It means dollar to pound is 1.4 now? so Dollar became stronger ?
in questions like, if exchange rate has fallen, exports are stimulated and imports became cheaper im getting confused when they say exchange rate has fallen. I dont understand that means.
1. It depends which country is higher, and which way round the exchange rate is quoted!!
2, If you are saying that the exchange rate moves from 1.5 to 1.4, then yes – since 1 pound is buying fewer dollars it means that the dollar is stronger and the pound is weaker.
Your question 2 is an example of where the exchange rates has fallen and the pound is weaker. It means that imports from the US will cost more in pounds to UK customers, but exports from the UK to the US will cost US people less – so hopefully they will buy more and exports to the US from the UK are therefore stimulated.
(I assume you mistyped, because imports being cheaper and exports being stimulated, certainly don’t both happen!!)
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