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Hi Mr John,
may you please explain the calculation and logic behind the purchasing power parity formula.
Buryecs based in Eurozone – currency EURO- should be base currency 6%
Wirtonia based in other place- currency USD – Should be overseas currency 3%if the company based in Eurozone , seems euro is base currency, USD should be overseas currency. why in formula overseas country is taken eurozone not wirtonia?
spot exchange rate between the Euro and Wirtonia $ is €0.1430 = $1
In the answer given – 0.143*(1+0.06)/(1+0.03)why not like this – 0.143*(1+0.03)/(1+0.06)
may you please explain this part.
thank you a lot.
It is not where the company is based that determines which is the ‘base’ currency and which is the ‘foreign’ currency.
It is determined by which currency is the exchange rate being quoted against. Here the exchange rate for the € is quoted against the $, Therefore as far as the formula is concerned, $ is treated as the base currency and € is treated as the other currency.
Do watch my free lectures on forecasting future spot rates where I also explain the logic behind PPP.
Hello! Sorry for my English. Why would ACCA make such a confusing text? It is unknown where the first swap’s terms end and where the second’s start. It turned out there are two swaps: a swap that exchange EUR to USD at the beginning and at the end of the three-year period in the dollar amount of 5,000 USD (more like a Forward contract to me) and the swap involving interest rates on loans on different currencies. They use “the swap …” wording with “the” when talking about the 0.5% fee which makes it look like some kind of a combined swap, but in fact, these are two separated swaps and the calculations are also separated . I spent 30 minutes trying to solve this riddle and I failed. It looks very unethical
Buryecs Co’s finance director (FD) has contacted its bankers with a view to arranging a currency swap, since he believes that this will be the best way to manage financial risks associated with the franchise. The swap would be for the initial fee paid for the franchise, with a swap of principal immediately and in three years’ time, both these swaps being at today’s spot rate. Buryecs Co’s bank would charge an annual fee of 0·5% in € for arranging the swap.
You are not being fair to the examiner because the question does make it clear that there will be a swap now and again in three years time and also that the reason for it is that they need to pay $’s now but will get back $’s in three years time.
That part of the question was difficult, but it was just 12 marks out of 25 marks and so answering the other parts of the question would have got the 50% needed to pass.
Thank you for the response. How about they use “the” in “the swap” in?:
“Buryecs Co’s bank would charge an annual fee of 0·5% in € for arranging the swap.”
It looks like that fee of 0·5% relates to the swap of providing currency rate exchange now and in three years time (let’s call it swap 1), but in fact it relates to interest rate swap (swap 2).
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