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International operations and international investment appraisal

2.2 Forecasting future exchange rates – parity theories

Parity theories

Purchasing power parity: Interest rate parity:

1 + h 1 + i
c
S = S × 1 + h F = S × 1 + i
c
0
1
0
0
b b

Where S 0 = the spot exchange rate

h c and h b = counter (c) and base (b) inflation rates

i c and i b = counter (c) and base (b) interest rates

S 1 = the expected spot rate in 1 year

F 0 = the forward exchange rate

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