(Ppp) Purchasing Power Parity

1. PPP. Explain the theory of purchasing power parity (PPP). Based on this theory, what is a general forecast of the values of currencies in countries with high inflation?

2. Rationale of PPP. Explain the rationale of the PPP theory.

3. Testing PPP. Explain how you could determine whether PPP exists. Describe a limitation in testing whether PPP holds.

4. Testing PPP. Inflation differentials between the United States and other industrialized countries have typically been a few percentage points in any given year. Yet, in many years annual exchange rates between the corresponding currencies have changed by 10 percent or more. What does this in- formation suggest about PPP?

5. Limitations of PPP. Explain why PPP does not hold.

6. Implications of IFE. Explain the international Fisher effect (IFE). What is the rationale for the existence of the IFE? What are the implications of the IFE for firms with excess cash that consistently invest 
in foreign Treasury bills? Explain why the IFE may not hold.

7. Implications of IFE. Assume U.S. interest rates are generally above foreign interest rates. What does this suggest about the future strength or weakness of the dollar based on the IFE? Should U.S. inves- tors invest in foreign securities if they believe in the IFE? Should foreign investors invest in U.S. securi- ties if they believe in the IFE?

8. Comparing Parity Theories. Compare and contrast interest rate parity (discussed in the previous chap- ter), purchasing power parity (PPP), and the inter- national Fisher effect (IFE).

9. Real Interest Rate. One assumption made in devel- oping the IFE is that all investors in all countries have the same real interest rate. What does this mean?

10. Interpreting Inflationary Expectations. If investors in the United States and Canada require the same real interest rate, and the nominal rate of interest is 2 percent higher in Canada, what does this imply

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