Parity Conditions in International Finance and Currency Forecasting

It is not for its own sake that men desire money, but for the sake of what they can purchase with it.



  • To describe the meaning of the “law of one price” and its importance to the study of international finance
  • To explain how arbitrage links goods prices and asset returns internationally
  • To list and describe the five key theoretical relationships among spot exchange rates, forward exchange rates, inflation rates, and interest rates that result from international arbitrage activities
  • To differentiate between the real and nominal exchange rate and the real and nominal interest rate
  • To list and describe the four requirements for successful currency forecasting
  • To identify a five-stage procedure for forecasting exchange rates in a fixed-rate system
  • To describe how to forecast exchange rates in a floating-rate system using the predictions already embodied in interest and forward rates
  • To describe the meaning and likelihood of forecasting success in both fixed-rate and floating-rate systems

On the basis of the flows of goods and capital discussed in Chapter 2, this chapter presents a simple yet elegant set of equilibrium relationships that should apply to product prices, interest rates, and spot and forward exchange rates if markets are not impeded. These relationships, or parity ...

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