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What are the two primary theories from international finance that try to predict FX rate changes...
What are the two primary theories from international finance that try to predict FX rate changes from CHANGES in interest rates? How are they different?
Solutions
Expert Solution
two important theories from the international finance that will be trying to predict the foreign exchange rates from the changes in the exchange rates are-
A. Interest rate parity- it will be trying to advocate that difference between the forward rate and spot rate is equal to the interest rate differential between two countries
B. Purchasing power parity theory will also help in order to determine the the changes in the prices of commodities in respect to change in the inflation and interest rates in different countries so that it will help in order to derive the future exchange rates.
they are different because interest rate parity is mostly focusing upon changing in the interest rates and it is trying to equalise the interest rate differential between the differences of the spot and forward rates whereas purchasing power parity will be reflecting the equalization of the purchasing power between two countries after the settlement of inflation and interest rates.
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