Question

Use Purchase Power Parity (PPP) and International Fisher Effect (IFE) to make foreign currencies forecasts for Nvidia Corporation. You need to explain what these are and discuss the accuracy of these techniques in forecasting exchange rate. In making one-year currency forecasts, for the IFE use the current spot exchange rates and the interest rates, and for the PPP use the current spot exchange rates and the inflation rate forecasts for 2020. For the IFE, if you cannot find the bond yield of government bill/note/bond rates for a relevant period, you may use the yield of a bond with a maturity date closest to 1 year from now.

The main three currencies that Nvidia is exposed against are Euro, Rupee and Taiwan dollars.

Answer 1

PPP concept

According to the Purchasing power parity or PPP principle, the volume of goods purchased in two country cost the same, The exchange rate adjust according to the cost of goods.

The formula for currency forecast using PPP and the calculations are:

IFE concept

The international fischer effect or IFE states that the spot exchange rate should change in future to adjust for the differences in interest rate between two countries.

The formula and calculation is below:

Accuracy of PPP and IFE :

Both PPP and IFE are poor methods for forecasting exchange rate. That is so because exchange rate does not follow the ideal principles and there are various fluctuations in the short run. These theories might give near accuarte values in the long run.

In PPP you use inflation which is again an estimate and is bound to errors. Thus, questioning the prediction made by PPP model.