PARITY RELATIONS

PARITY RELATIONS

1. Value in relation to foreign currencies is determined by supply and demand

   • Dollar, Euro, Yen, Franc, British pund Swiss. Flexible of Floating
     • Are freely exchanged on the foreign exchange market.

2. BALANCE OF PAYMENTS

   • Tracks financial flows crossing a country's borders suring a period
     • Current Acount
       • Current transactions that take place in the normal bussiness of residents of a country
       • -Exports & Imports -Services -Income
     • Financial Account
       • Investments by residents abroad & investments by nonresidents in the home country
       • -Direct,Portafolio Investment

3. Differences in National Inflation Rates

   • A country's M & X depend on the relative prices of foreign-produces and domestically produced goods.

4. Government Policies

   • Monetary Policy and the Foreign Exchange Rate
     • -Real interest rate will temporarily drop. -Upward pressure on the domestic price level, inflation will accelerate
   • Fiscal Policy and the Foreign Exchange Rate
     • Restrictive implies less goverment borrowing, should induce a reduction in the domestic real interest rate

5. EXCHANGE RATE REGIMES

   • Flexible
     • Exchange rate between two currencies fluctuates freely in the foreign exchange market
   • Fixed
     • Exchange rate between two currencies remains fixed at a preset level. Official parity
   • Pegged
     • Compromise between a flexible and a fixed exchange rate. emerging countries use it.

6. 1. Interest rate parity relation, linking sport exchange rates, forward exchange rates, and interest rates by the no arbitrage condition

   • 2. Purchasing power parity relation, linking sport exchange rates and inflation
     • 3. International Fisher Relation, linking interest rates and expect inflation
       • 4. Uncovered interest rate parity relation, linking spot exchange rates, expect exchange rates, and interest rates
         • 5. Foreing exchange expectations relation, excahnge rates and expect sport exchange rates

7. Combining the Relations

   • Insterest rate differential: Forwaer discount equals the interest rate differential
   • Inflation differential: Exchange rate movement should exactly offset any inflation dif.
   • Expect inflation rate differential: matched by the interest rate differential, real interest are equal
   • Interest rate diferrential: Expect to be offset by the currency depreciation
   • Expect exchange rate movement: Forward discount is equal to the expect exchange to it.

8. ELABORATED BY: Fernanda Cruz García