International Business MGCR 382 - Exchange Rates – Parity Conditions

A series of flashcards summarizing key concepts and theories related to exchange rates and parity conditions in international business.

Law of One Price

If identical products can be sold in two markets without restrictions, their prices should be equal when expressed in the same currency.

Purchasing Power Parity (PPP)

A theory stating that exchange rates should adjust so that the purchasing power of currencies is equal when compared to a basket of goods.

Absolute Purchasing Power Parity

The theory that the exchange rate between two currencies is equal to the ratio of the prices of a basket of goods in the two countries.

Relative Purchasing Power Parity

A theory stating that the change in the exchange rate over time is equal to the difference in inflation rates between two countries.

Big Mac Index

A measure of purchasing power parity based on the price of a Big Mac in different countries to assess valuation between currencies.

Undervalued Currency

A currency that is trading below its estimated true value based on purchasing power parity.

Fisher Effect

The relationship between nominal interest rates and expected inflation, suggesting that an increase in expected inflation leads to an increase in nominal interest rates.

Approximate Fisher Effect

A simplified version of the Fisher effect that omits the product of the real rate and expected inflation due to its relatively minor impact.

International Fisher Effect

The theory that the difference in nominal interest rates between countries will be offset by changes in exchange rates.

Interest Rate Parity (IRP)

A theory stating that the interest rate differential between two countries is equal to the difference in forward and spot exchange rates.

Covered Interest Arbitrage

A strategy to exploit the interest rate differential between two countries using forward contracts to hedge against exchange risk.

Uncovered Interest Arbitrage

A method that involves borrowing in a currency with a low interest rate and investing in a currency with a higher interest rate without hedging exposure to exchange rate risk.

Forward Rate Calculation

A method to determine the future value of a currency pair based on current spot rates and interest rates.

Unbiased Predictor

The idea that the forward exchange rate is an average predictor of the future spot exchange rates with no bias in over or underestimating.

Transaction Costs

Costs incurred when making a trade, which can affect arbitrage opportunities and market equilibrium.