The paper "The Law of One Price - Purchasing Power Parity" describes that the Law of One Price is one of the pointers that PPP may hold since international products have a relation to it. Thus the cost of a product that is internationally traded ought to be similar at any given country in the world…
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Multinational companies operating in countries such as those may be faced by risk emanating from their trade especially when there is a drawdown as well as repayment of Import/ Export Forex Loans in addition to disbursements of import/Export Bills denominated mostly in foreign currencies. Such companies will also be faced with risk emanating from Inward/Outward Remittances which are also denominated in currencies from other countries. There is also risk coming from overseas dividends that are arising from repatriating profit from overseas back home as well as operating expenses of overseas such as paying employees working in overseas. Lastly, foreign exchange risk may emanate from assets held in overseas countries such as excess cash balances of subsidiaries operating in overseas together with overseas liabilities that may result from the borrowing of foreign currency (Sharan, 2012).
These fluctuations in foreign exchange rates may trigger changes in the value of the cash flows, liabilities and assets, particularly when they are denominated in foreign currencies. This means, therefore, such fluctuations may adversely affect a company’s outgoing import disbursements and incoming export funds. This is why management of foreign exchange risk is very important since it can help in minimising the risk or maximising the firm’s profit (Berg, 2010).
A managed floating exchange rate is crucial for not only economic restructuring but also optimization of allocation of resources. This is because an exchange rate symbolizes price relations that exist between non-tradable and tradable goods and services. A regime of managed floating exchange rate improves the effectiveness of resource allocation, direct resources to the economic sectors that are mainly fuelled by domestic demand, for instance, the services sector, promotion of industrial upgrading, transformation of the economic pattern development, reduction of trade imbalances together with over-reliance on exports, all these stimulate economic demand to have an influential role in economic development and hence leads to promotion of balanced and sustained economic growth.
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...?I. PurchasingPowerParity Generating Eviews work file By inspecting the dataset Data_Canada_PPP.xls, it is analysed that the data consists of 3 series Exchange_rate (Canadian dollar to US dollar nominal exchange rate), CPI_Can (Canadian Consumer Price Index) and CPI_US (the US Consumer Price Index) that are observed every month from the year 1990/1 till 2011/3. A new Eviews workfile is generated from the main menu of the Eviews by selecting File/New/Workfile, which opens up the create workfile dialogue box. Dated-regular frequency is chosen as the workfile structure type, frequency is chosen as monthly with the start date as 1990-1 and end date as...
1. Theoretical Foundations and Formulation of the econometric model
The central notion of the purchasingpowerparity hypothesis is that the exchange rate between the currencies of two economies is determined by the relative price levels of the two countries. Alternatively one could also perceive this theory as saying that the changes in the exchange rate are driven by changes in the relative price levels (Froot and Rogoff, 1995). If we define as the exchange rate between currencies of country A and country B, and as the price level of...
...combination or basket of goods should be equalized. But this does not always hold true. The reason being
1. Import and Export Restrictions: Restrictions such as quotas, tariffs and laws will make it difficult to buy goods in one market and sell them in another.
2. Travel Costs: If it is very expensive to transport goods from one market to another, we would expect to see a difference in prices in the two markets.
3. Perishable Goods: It may be simply physically impossible to transfer goods from one market to another.
4. Location: Because of that real-estate prices in markets can vary wildly. Since the price of land is...
...PowerPurchaseParity July 5, 2006 Purchasepowerparity is often used to describe the relationship of exchange rates between economic and national boundaries. This theorem relies heavily and implicitly on the concept of relative pricing. Exchange rates are, however, not only defined by the theory of relative pricing, but many other factors. This paper looks at the definitions of exchange rates and relative pricing as well as their relationship in purchasepowerparity to discover if the hypothesis of purchasepowerparity is true. The purchasepowerparity hypothesis is based on the law of oneprice, that the equilibrium of trade between boundaries is constant. The conclusion is that this is highly assumptive and neglects other... ...
...The Role of the PurchasingPowerParity in the Real World In its strictest definition, the theory of the purchasingpowerparity s that, "the exchange rate between countries' currencies equals the ratio of their price levels, as measured by the money prices of a reference commodity basket" (Krugman and Obstfeld, 2000). Developed in the early 1900s by a man named Gustav Cassel, this theory was based on the idea that in an ideal world with an efficient market, the same goods should have the same price universally.
The law of oneprice,...
...PURCHASINGPOWERPARITY "Purchasingpowerparity" or "PPP" expresses the notion that with a unit of purchasingpower, say one dollar or one euro, it should be possible to purchase the same bundle of goods and services anywhere in the world (Neary, 2004). In economics, purchasingpowerparity (PPP) is the method of using the long-run equilibrium exchange rate of two currencies to equalize the currencies purchasingpower. It is based on the law of...
...PURCHASINGPOWERPARITY By of the of the School Data We collected monthly consumer price index (CPI) time series data spanning from 1st January 1955 to 1st December 2013 from the Federal Reserve Economic Data. We however manipulated the data to have them in annual form and computed PurchasingPowerParity (PPP) using 2002 as the index (base) year. We used data from UK since previous research has shown that they are the most commonly used data set to test for PurchasingPowerParity (PPP).
Before conducting any serious analysis we ran some basic...
...by considering the prices of products and the prevailing currency exchange rates during the trading period.
The expectation of this model is to obtain the persistent stochastic trends based on the economy. The movements of the actual rates of exchange and interests form the fundamental positions during the trade period. We will thus conduct an econometric test in a CVAR available in the actual exchange rate, and will be empirically approaching the actual interest rate differential.
From the discussion, the fundamental long-term relationships include the purchasingpowerparity, the actual rates of interest, the ration of capital to income, the UIP (uncovered...
...price takers rather than the decision makers. The nations take the market prices, affecting the states of their economy from time to time. Another major hindrance is the fact that these countries often make deals with exporters, where they get foreign aid, but have to rely on the country’s products. At such situations, the African nations have no choice but to take the fixed prices set in markets. Such limitations result to the depreciation of the countries’ currencies in the markets. Consequently, their exchange rates deteriorate and their purchasingpower is therefore affected by the weakening currency.
The author explains the mechanism of the...
It states that the country which is having high inflation rate is weak in terms of currency because inflation reduces the real purchasing power of a nation’s currency. It predicts a relationship between the inflation rates of two countries over a specified period and the movement in the exchange rate between their two currencies over the same period which means that the exchange rate of two currencies reflects the effect of inflation rate (Murphy, p.1). Absolute PPP states that the value of 2 currencies changes in contrary proportion to the changes in the ratio of price levels. On the other hand relative, PPP predicts a relationship between the inflation rates of two countries over a specified period and the movement in t...
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