IRP vs PPP vs IFT - Comparison between Interest Rate Parity, Purchasing Power Parity and International PDF

Title	IRP vs PPP vs IFT - Comparison between Interest Rate Parity, Purchasing Power Parity and International
Author	Maksudur Rahman
Course	International Finance
Institution	Institute of Business Administration
Pages	1
File Size	94.4 KB
File Type	PDF
Total Downloads	61
Total Views	136

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Summary

Comparison between Interest Rate Parity, Purchasing Power Parity and International Fisher Effect
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Description

Meaning

Implicatio n

Variables

Theory 1 (Interest Rate Parity)

Theory 2 (Purchasing Power Parity)

Theory 3 (International Fisher Effect)

IRP refers to a state where the forward discount of the higher interest currency exactly offsets the interest rate differential between the two countries. It basically implies that no investor can earn a rate of return higher than that attainable in his or her home country by investing overseas.

It refers to a situation where the inflation differential between two countries is exactly offset by the depreciation of the higher inflation currency. When PPP exists customers will be indifferent between purchasing goods in their own country versus purchasing goods in the foreign country.

It proposes that differences in nominal interest rates between countries are reflective of differences in anticipated inflation.

Forward rate of the foreign currency relative to the spot rate and the interest rate differential between the home country and the foreign country.

Change in the spot rate of the concerned currencies and inflation differential between the two countries.

If interest rates in a country are higher, that is a sign of higher anticipated inflation. Hence, according to PPP the higher interest currency will depreciate and investors will earn the same return whether they invest in the home country or the foreign country. Interest rate differential between two countries and percentage change in the spot rate of the foreign currency.

Exact Equation Approxima te Equation

It is to be noted that the difference in nominal interest rate (1%) = difference in expected inflation (1%) Therefore, we can say that investors/savers in the US are demanding 1% higher nominal interest rate to compensate for the 1% extra expected inflation in their country...