Analytical Application Coursework Example | Topics and Well Written Essays - 1250 words

Analytical Application - Coursework Example unsophisticated Annual inflation rate Spot rate regular army 3% N/A UK 4.2% 1.62 Substituting the values in the purchasing creator parity formula Forward rate = ( 1 + 0.042 ) x 1.62 1 + 0.030 Forward rate = 1.639 Answer 2 The appreciation / (Depreciation) in the British pound using the take rate parity theory is as follows Country Spot rate maven year in advance rate Appreciation / (Depreciation) Percentage UK 1.62 1.633 0.013 0.80% The appreciation / (Depreciation) in the British pound using the purchasing power parity theory is as follows Country Spot rate One year onward rate Appreciation / (Depreciation) Percentage UK 1.62 1.639 0.019 1.17% Answer 3 The forecasted prior rate using both interest rate parity theory and the purchasing power parity theory appears to be an unbiased estimate of the proximo spot rate of the currency. Interest rate is a very important factor in determining the relative exchange rate in an economy and in most countries the Federal Reserve and Central Banks publish the forward exchange rates of the foreign currencies using the preponderant interest rate in the economy. Similarly, the forecast of rate using the purchasing power parity theory can also be concluded as the unbiased estimation of the forward rate. Answer 4 According to the interest rate parity theory, the difference between the interest rate of two countries is equal to the differential between the forward exchange rate and the spot exchange rate of two countries. In the current global economy, interest rate parity theory plays a groovy part in connecting the interest rates and exchange rates of two countries. The origin of this theory can be associated to an article written by Walther Lotz in 1884 which was concerned with the Vienna forward market. In 1927, another renowned economist Keynes pointed out the fact that forward premiums are affected by the relative interest differential. There are certain assumptions wh ich need to be considered. The securities, both domestic and foreign, are considered to be identical in terms of maturity time and risk. It is the prevailing interest rate on these securities that is utilized in the interest rate parity calculation. In addition, it is also assumed that there are no swell controls or transaction cost and market imperfections. Purchasing power parity theory is another theory widely used in determining the forward rates of a particular currency. As per this theory, when a countrys inflation rate rises, the demand for its currency declines as its exports also declines due to the high prices. As a corresponding impact, the importers and firms in that country start putting more emphasis on the imported goods and other items. These two factors in confederacy cast a downward impact on the high inflation of a countrys currency. Inflation rates do not bear on constant between countries which cause international trade patterns and exchange rates to adjust accordingly. There are two forms of purchasing power parity theory. One is absolute form and the other is relative form. The