Inflation and Power Parity Level

CHAPTER 4
Parity Conditions in International Finance and Currency Forecasting

EASY (definitional)

4.1 In its absolute version, purchasing power parity states that price levels worldwide should be _______when expressed in a common currency.
a) equal
b) roughly equal
c) different
d) opportunities for arbitrage

Ans: a
Section: Purchasing power parity

Level: Easy

4.2 The theory of relative purchasing power parity states that, between two nations, the
a) inflation rates are unrelated
b) exchange rate differential reflects the inflation rate differential
c) inflation rate is smaller in weaker currencies
d) the interest rate is greater than the inflation rate during depreciations

Ans: b
Section: Purchasing power parity

Level: Easy

4.3 The Fisher effect states that the _________ rate is made up of a real required rate of return and an inflation premium.
a) nominal exchange
b) real exchange
c) nominal interest
d) adjusted dividend

Ans: c
Section: The fisher effect
Level: Easy

4.4 A rise in the inflation rate in one nation relative to others will be associated with a fall in the first nation’s exchange rate and with a rise of its interest rate relative to foreign interest rates. The two conditions combined result in the _________ Effect.
a) Fisher
b) Herstatt
c) Unbiased forward rate
d) International Fisher

Ans: d

Section: The fisher effect
Level: Easy

MEDIUM (applied)

4.5 Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%, respectively, over the next several years. If the current spot rate for the Mexican peso is $.005, then the best estimate of the peso's spot value in 3 years is
a) $.00276
b) $.01190
c) $.00321
d) $.00102

Ans: d
Section: Purchasing power parity
Level: Medium

4.6 If the expected inflation rate is 5% and the real required return is 6%, then the Fisher effect says that the nominal interest rate should be
a) 1%
b) 11.3%
c) 11%
d) 6%

Ans: b
Section: The fisher