Explain how the law of one price establishes a relationship between changes in currency values and inflation rates.
Answer to relevant QuestionsWhy does purchasing power parity appear to hold in the long run but not in the short run? Using the data presented in Figure 18.1, calculate the spot exchange rate on Wednesday between Canadian dollars and British pounds (in pounds per Canadian dollar). Go to http://www.economist.com. Under Economics, Markets & Data, find the link for the “Big Mac index.” After exploring this part of the site, explain why the Big Mac index might foreshadow changes in exchange rates. ...What is the difference between an option’s price and its payoff? Draw a payoff diagram for the following portfolio: Buy two call options, one with X = $20 and one with X = $30, and sell two call options, both with X = $25.
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