Question: Explain the Purchasing Power Parity theory and its implications in international finance.Clearly describe the importance of the assumptions in this model. 2.Calculation(10marks).The rate of inflation

Explain the Purchasing Power Parity theory and its implications in international finance.Clearly describe the importance of the assumptions in this model.

2.Calculation(10marks).The rate of inflation in the U.S. is expected to be 9%, while rate of inflation in Canada is expectedto be 5% over the next 12 months.Today you receive an offer to purchase a one-year put option for $0.03 per unit on Canadian dollarsat a strike price of $0.72.

The Canadian dollar is quoted at $0.70 today.

You believe that purchasing power parity holds.

What is the rate in 12 months, and should the option be accepted?

3.Explain the International Fisher Effect Theory and its implications in international finance.Clearly describe the importance of the assumptions in this model.

4.Calculation

Assume that the interest rate offered on EUROS is 5% and the EURO is expected to depreciate by 1.5%. For the international Fisher effect (IFE) to hold between the France and the U.S., what should the U.S. interest rate be?

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The theory was proposed by Swedish professor Gustav Cassel Purchasing power parity PPP is an economic theory of exchange rate determination It states that the price levels between two countries should ... View full answer

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