Question

If the theorys of purchasing power parity and international fisher effect hold is there any reasons international companies should hedge?

In other word is there exchange rate risk for companies if purchasing power parity and the international fisher effect were true?

Answer 1

The purchasing power parity and International fisher effect both focuses on the exchange rate movement of one currency with reference to other currency. One thing to note here is that PPP and IFE, these two do not necessarily hold in the short-term but they do hold in the long-term but the definition of long-term is not very clear as to how much is long-term? Another issue is even if the PPP and IFE holds the risk has to be managed for existing positions and you have to take hedging positions, just because the risk is predictable does not mean that the risk is eliminated completely. The risk is still there and foreign exchange fluctuation can significantly affect the income statement of the company. The exchange rate risk is still there because inflation can change, interest rate can change and so the exchange rate can also change. The foreign exchange rate risk can be affected by many factors but if the purchasing power parity (PPP) and international fisher effect (IFE) holds then the risk can be managed easily and effectively.