Question

1. i) Explain relative purchasing power parity; and ii) give an example to support your answer.
2. i) What is political risk; and ii) give an example of a significant political risk faced by any company operating/trading internationally of your choice.

Answer 1

a. i. Relative Purchasing Power Parity (RPPP) is a carry-forward of the Purchasing power parity theory which states that countries with inflation rates higher than another country will have a devalued currency rate compared to the lower inflation country. This can be understood in a way that the difference in inflation between two countries is the driving factor for difference in the currency exchange rate between the said countries.

ii. Let's take example of USA and India. Assume that inflation in USA over the next year is 3% whereas inflation in India is expected to be 7%. Therefore, the difference between USA and India's inflation will be 4% (4 percentage points). According to RPPP, this difference will drive an equivalent 4 percentage points difference between the currency exchange rate of USA and India leading to India Rupee depreciating by 4% (or in other words, USD appreciating by 4%).

b. i. Political risk can be viewed as a component of risks associated with investments where the value of an investment or asset held in a particular country 9domestic or internationally) is adversely affected by the unstable political scenario in that country. This unstable political scenario could comprise of changing or weakening government position in the country, changes in strong legislative bodies, changes in foreign or military policies or actions of the country, etc. overall affecting the potential returns from an investment or business venture in that country.

ii. An example of political risk is the risk faced by IT or Tech companies in the United States of America on account of the changing or challenged immigration policies affecting the eligibility of immigrant employees to work in the country, thus, potentially impacting business operations.