Week 4 Discussion
What is the Absolute and Relative PPP?
Absolute Purchasing Power Parity is the notion that the trend of exchange rate between countries is directly proportional to the price levels of such nations (Domowitz 11). Consequently, the price of merchandise is equal in all trading countries. However, the Relative Purchasing Power Parity links the changes of a country’s rate of inflation to its exchange rate changes as well. As such, inflation differentials are compensated by alterations inn the exchange rate.
What is the Real Effective Exchange Rate Index?
It is the average calculation of the bilateral Real Exchange Rates of a nation with those of other trading blocks in comparison to their respective trading shares (Jones 1). Therefore, it is the measure of a currency’s change in exchange rates against others, which have undergone inflation adjustments. By so doing, the extent of competitiveness in the international market can be illustrated.
What is the Fisher Effect?
The above is the practice of nominal interest rates changing in correspondence to alterations in the rate of inflation resulting from money supply changes. An increase in the former thus causes a rise in the latter as well (Beggs 1).
Does the International Fisher Effect exist in practice?
The International Fisher effect is just a model because the real and nominal interest rates are not out rightly known (Ray 2170). They are an approximation, which assume nominal interest rates in every nation are similar to the obligated real rate of return including any inflation compensation. Therefore, the IFE is dependent on the rate of real inflation, which is a lagging indicator that keeps changing due to market forces.
What is the relationship between interest Differentials and Forward Discount or Premium?
In international trade, one country’s central bank or any other financial institution sets an exchange rate that it would be willing to transact business on at a future date hence hedging such funds presently. Nevertheless, changes in the interest rates affect the amount of premiums to be paid by reducing this figure in tandem with a lowering of such rates. Such quotations are thus subjected to readjustments depending on the behavior of the markets thereby affecting the final disbursement upon maturity.
What is the CIA?
Cash In Advance refers to the scenario whereby a buyer pays for merchandise before they are delivered. It also involves services as well. Sometimes, it is known as cash before delivery and various procedures are incorporated (Dotsey 632). Such guidelines seek to cushion the consumer from unnecessary delays or damage to the goods hence ensuring that the supplier is liable for any default to the agreement.
Is the Forward Rate an Unbiased Predictor of the Future Spot Exchange Rate?
The forward rate is a biased predictor of future spot exchange rate because of its regression on the depreciation value. In particular, this occurs when the arte is placed against the forward premium thereby producing conflicting results to those that base on the forward rates (Kang 221). Moreover, the forward rate is influenced by speculation and arbitrage hence making it difficult to make future spot exchange rate forecast. Changes in the current spot rate and forward rate result in alterations of the forward premium thus influencing its outcomes.
Is the Foreign Exchange Market Efficient?
The foreign exchange market is efficient due to the quick transition resulting from unpredictable variables that may occur in future. For example, political instability or alterations to certain goods may trigger realignment of foreign markets thereby affecting the value of different currencies (Levich 12). Moreover, while exchange rate differences exist, speculative activity about the course of various currencies affected by macroeconomic variables helps to mitigate risks thereby avoiding huge losses. However, the structure of the market makes it possible to compensate such losses with a rise in interest rates that compensate for the reductions.
Beggs, Jodi. The Fisher Effect. AboutEducation. 12 January 2015. Web. 27 January 2015. <http://economics.about.com/od/interest-rates/ss/The-Fisher-Effect.htm>
Domowitz, Ian. Absolute Power Parity and Relative Power Parity. Institutional Investor Journal, 2013. Print.
Dotsey, Michael. Cash In Advance. Journal of Monetary Economics, 45.3 (2000): 631-655. Print.
Jones, Peter. Real Effective Exchange Rate. Macroeconomic Analysis, 26 March 2008. Web. 27 January 2015. <http://macroeconomicanalysis.com/macroeconomics-wikipedia/real-effective-exchange-rate-reer>