INTERNATIONAL FINANCE NOTES
Real Exchange Rate – Considers the Purchasing Power Parity
- The nominal rate does not include the Purchasing Power Parity
When the Real exchange rate is equal to one - One bundle In one country equals one bundle in another country – Purchasing power parity
Profit must be compared to its purchasing power to get a real feel for what the currency is actually worth (how many bundles can you buy for your profit) Cadillac or a piece of bread
There are particular bundles that they use to measure
Income = Revenue – Expenses
Revenue = What you sell
Revenue – Cost = Profit
Nominal Profit = Revenue for both countries added – firms (domestic costs)
An increase in the general price level – Inflation
If the inflation rate rises at an equal amount in both countries than the isk is reduced to a nominal risk
Price elasticity – ((Change in Q/Q)/Change in P/P))
1+rs(t+1,a/b) = [1+pi(t+1,b)]x[1+s(t+1,a/b)]
1+pi(t+1,a)] How do we get this formula?
Learn to identify each part of the formula
Pi(t+1) = Pi(t+1)-P(t)/P(t)
Increase in the nominal exchange rate or an increase in the inflation rate can drive this equation up
Relative purchasing power parity – No change in the real exchange rate
Rate of change formula
1+s(t+1,$/E) The model for The real Exchange Risk slide = Zero – Not expecting the real exchange rate to change
Calculating the price level
P(t,+$) = SUMN i=1 WiP(t,i,$)
where P(t, i, +$) represents the dollar price of good i at time t,
wi represents the weight or consumption share of good i
P(t, $) is the dollar price level, the weighted average of the dollar prices of the N different goods and services.
Calculating the annual rate of inflation
Subtract 1 from the ratio of price idexes
Cumulative Rate of Inflation
Ratio of price indexes ^ (1/number of years)
Internal Purchasing Power of the dollar at time t is
1/purchasing power of the dollar at...