Page 236 - Microsoft Word - 00 ACCA F9 IWB prelims 2017.docx

Chapter 13

The causes of exchange rate fluctuations

4.1 Purchasing power parity theory (PPPT)

PPPT claims that the rate of exchange between two currencies
depends on the relative inflation rates within the respective countries.

 ‘the law of one price’

 the country with the higher inflation rate will be subject to a
depreciation of its currency.

Formula to estimate expected future spot rates:

(1 + h c)

S 1 = S 0 × ––––––
(1 + h b)

Limitations:

 the future inflation rates are estimates

 the market is dominated by speculative transactions

 government may intervene to manage exchange rates

228