Chapter 6

Question 1

The economic theories that link exchange rates, price levels, and interest rates together

Answer 1

International parity conditions

Question 2

When parity conditions hold, markets are in equilibrium, and therefore market price =

Answer 2

Intrinsic price

Question 3

Law of one price

Answer 3

Long Term Theory

Question 4

Law of One Price
Under the assumptions of:
If the identical product or service can be

Answer 4

• sold in two different markets
• no restrictions exist on the sale
• or transportation product between markets
  then the product’s price should be the same in both markets

Question 5

The exact exchange rate between two currencies could be found by equalizing the purchasing power of the two currencies.

Answer 5

The absolute Purchasing power parity theory

Question 6

The _______ _______ of the PPP theory states that: the spot exchange rate is determined by the relative prices of similar basket of goods.

Answer 6

absolute version

Question 7

A primary principle of competitive markets is that

Answer 7

prices will equalize across markets if frictions do not exist

Question 8

By comparing the prices of identical products denominated in different currencies, we could id

Question 9

Does the absolute PPP hold in reality? Why

Answer 9

No

-Goods differentiation
-Differences in tastes and preferences
-Services and items which cannot be traded
-Transportation costs
-Tariffs and barriers to trade

Question 10

Why should we still use absolute PPP?

Answer 10

It lets us know the direction that we need to go into

Question 11

PPP is not particularly helpful in determining what the spot rate is today, but the relative change in prices between two countries over a period of time determines the change in the exchange rate over that period

Answer 11

Relative purchasing power parity (relative PPP)

Question 12

Changes in price

Answer 12

Inflation

Question 13

if inflation increases in the US by 5% relative to the UK, you expect a _ _________ of the pound or a _ __________ of the dollar

Answer 13

5% appreciation; 5% depreciation o

Question 14

the degree to which the prices of response of imported and exported product change as a result of changes in exchange rates

Answer 14

Exchange rate pass-through

Question 15

one reason that country’s real effective exchange rate index can deviate from its PPP equilibrium point

Answer 15

Incomplete (Partial) exchange rate pass-through

Question 16

All changes in exchange rates are passed on through by equivalent changes in prices

Answer 16

Complete pass-through

Question 17

What’s an important factor when determining pass-through levels

Answer 17

Price elasticity of demand

Question 18

The difference in the national interest rates fro securities of similar risk and maturity should be equal to, but opposite in sign to, the forward rate discount or premium for the foreign currency, except for transaction costs

Answer 18

Interest Rate Parity (IRP)