Multinational Corporate Finance (641) Mid Term Note Syllabus Content

Chapter: 1 An Overview of International Finance:

1. Main Goal of the Multinational Corporation

Ans: The main goal of a multinational corporation (MNC) is to maximize

shareholder value by generating profits and increasing the value of its stock. To
achieve this goal, MNCs typically aim to expand their operations and market
share globally, leveraging their strengths in innovation, marketing, and
operational efficiency.
In pursuit of their objectives, MNCs may engage in various activities, including
mergers and acquisitions, strategic alliances, joint ventures, and investments in
new markets. They may also focus on cost-cutting measures, such as outsourcing
and offshoring, to improve efficiency and reduce expenses.
While profit maximization is the primary goal of MNCs, many also prioritize
corporate social responsibility and ethical behavior, recognizing that these factors
can have a significant impact on their reputation, brand image, and long-term
success. As such, MNCs may invest in environmental sustainability initiatives,
social impact programs, and other efforts to support local communities and
promote ethical business practices.

2. Potential Conflicts with Multinational Corporation Goal

Ans: While the primary goal of multinational corporations (MNCs) is to

maximize shareholder value, there may be potential conflicts with this goal that
arise due to various factors. Some of these potential conflicts include:
1. Ethical considerations: The pursuit of profits may clash with ethical
considerations, such as environmental sustainability, human rights, and
labor standards. MNCs may face criticism for engaging in practices that
harm the environment or violate the rights of workers or local
communities.
2. Political instability: MNCs may face challenges in countries with unstable
political environments or regulatory frameworks that do not align with
their goals. This may lead to difficulties in expanding operations or
entering new markets, as well as potential reputational damage
 3. Social and cultural differences: MNCs may encounter social and cultural
differences in the countries where they operate, which can affect their
ability to conduct business effectively. For example, local customs and
traditions may clash with the MNC's marketing or branding strategies,
leading to negative perceptions among consumers.

4. Economic conditions: MNCs may face challenges in countries with

volatile economic conditions, such as high inflation rates, currency
fluctuations, or trade barriers. These factors can impact the MNC's
profitability and ability to generate returns for shareholders.
Overall, MNCs must navigate these potential conflicts to achieve their primary
goal of maximizing shareholder value while also considering the interests of other
stakeholders, such as customers, employees, and the communities in which they
operate.
3. key theories that justify international business

Ans: There are several key theories that justify international business, which
include:
1. Comparative Advantage Theory: Developed by economist David
Ricardo, this theory argues that countries should specialize in producing
goods and services in which they have a comparative advantage (i.e., they
can produce more efficiently or at a lower cost than other countries). By
engaging in international trade, countries can exchange these goods and
services with each other, leading to overall economic growth and increased
welfare.
2. Product Life Cycle Theory: Developed by economist Raymond Vernon,
this theory argues that a product's life cycle has three stages: introduction,
growth, and maturity. During the introduction stage, the product is
produced in the home country and exported to other countries. As the
product becomes more established, production shifts to other countries
where labor and other costs are lower. Eventually, the product becomes
standardized and is produced in many countries, leading to a decline in
international trade.
3. Internalization Theory: Developed by economist Ronald Coase, this
theory argues that firms engage in international business to reduce
 transaction costs (e.g., the costs of negotiating and enforcing contracts with
suppliers and customers). By internalizing these transactions within the
firm (e.g., by establishing subsidiaries or joint ventures in other countries),
firms can reduce their transaction costs and achieve greater efficiency.
4. Eclectic Paradigm: Developed by economist John Dunning, this theory
argues that firms engage in international business to exploit ownership
advantages (e.g., specialized knowledge, technology, or brand reputation),
location advantages (e.g., access to natural resources or markets), and
internalization advantages (e.g., the ability to internalize transactions
within the firm). By leveraging these advantages, firms can achieve
competitive advantage and enhance their profitability.
Overall, these theories provide a framework for understanding why firms
engage in international business and how they can achieve competitive
advantage and increase their profits by doing so.
4. The Common Method used to conduct international business

Ans: There are several common methods used to conduct international

business, which include:
1. Exporting: This involves producing goods or services in one country and
selling them to customers in another country. Exporting is a common
method used by small and medium-sized enterprises (SMEs) to enter new
markets.
2. Licensing: This involves granting another company (the licensee) the right
to use a company's intellectual property (e.g., patents, trademarks, or
copyrights) in exchange for a fee or royalty payment. This method is often
used by companies that have developed a strong brand or technology but
do not want to invest in establishing operations in a foreign country.
3. Franchising: This involves granting another company (the franchisee) the
right to use a company's brand, products, and operating systems in
exchange for a fee or royalty payment. This method is commonly used in
the retail and hospitality industries.
4. Joint Venture: This involves forming a partnership between two or more
companies to jointly operate a business in a foreign country. Joint ventures
are often used by companies to gain access to local knowledge, resources,
and distribution channels
 5. Foreign Direct Investment (FDI): This involves establishing operations
in a foreign country by setting up a subsidiary or acquiring an existing
company. FDI is often used by companies that want to have more control
over their operations in a foreign country or that want to gain access to
local resources, such as labor or natural resources.
Overall, the choice of method used to conduct international business depends on
a variety of factors, including the company's goals, resources, and the regulatory
environment in the foreign country.
Chapter: 2 International Financial Market
1. Foreign Exchange Market

Ans: The foreign exchange market, also known as the forex market or FX
market, is a global decentralized market for trading currencies. It is the largest
financial market in the world, with an average daily trading volume of over $5
trillion.
The foreign exchange market facilitates the exchange of one currency for another
between buyers and sellers all over the world, at the current market price.
Participants in the foreign exchange market include commercial banks, central
banks, investment management firms, corporations, hedge funds, and retail forex
traders.
The foreign exchange market is open 24 hours a day, five days a week, allowing
for trading to take place across time zones. The market operates on a continuous
basis, with transactions taking place electronically or over-the-counter.
The foreign exchange market is influenced by a variety of factors, including
economic and political events, interest rates, and inflation rates. Changes in any
of these factors can lead to fluctuations in currency exchange rates, which can
have a significant impact on businesses, investors, and the overall economy.
2. International Money Market

Ans: The international money market is a global marketplace where various

financial instruments such as currencies, short-term debt securities, and other
money market instruments are traded. It is an important part of the global
financial system and is used by governments, central banks, corporations, and
financial institutions to manage their short-term funding needs.
The international money market is characterized by short-term borrowing and
lending transactions, usually for periods of less than one year. The instruments
traded in this market include treasury bills, commercial papers, certificates of
deposit, and repurchase agreements. These financial instruments are typically
issued by governments, financial institutions, and corporations to meet their
short-term funding needs.
One of the main functions of the international money market is to provide
liquidity to participants by allowing them to borrow and lend money at a
competitive rate. The interest rates in the international money market are
determined by supply and demand factors and are influenced by a variety of
economic and political events.
The international money market is also closely linked to the foreign exchange
market, as currency exchange rates play a critical role in determining the interest
rates for different currencies. Changes in currency exchange rates can have a
significant impact on the international money market, as they can affect the cost
of borrowing and lending money in different currencies.
Overall, the international money market plays a vital role in the global financial
system by providing short-term funding to participants and facilitating
international trade and investment activities.
3. International Credit Market

Ans: The international credit market is a global marketplace where various

types of credit instruments such as bonds, loans, and credit derivatives are traded.
It is an important part of the global financial system and is used by governments,
corporations, and financial institutions to raise capital to finance their activities.
The international credit market is characterized by long-term borrowing and
lending transactions, usually for periods of more than one year. The instruments
traded in this market include corporate bonds, government bonds, syndicated
loans, and credit default swaps. These instruments are issued by governments,
financial institutions, and corporations to raise funds for various purposes such as
funding capital investments, financing mergers and acquisitions, and refinancing
existing debt.
One of the main functions of the international credit market is to provide liquidity
to participants by allowing them to raise funds at a competitive rate. The interest
rates in the international credit market are determined by supply and demand
factors and are influenced by a variety of economic and political events.

The international credit market is also closely linked to the foreign exchange
market, as currency exchange rates play a critical role in determining the cost of
borrowing and lending money in different currencies. Changes in currency
exchange rates can have a significant impact on the international credit market,
as they can affect the cost of servicing debt and the willingness of investors to
lend money.
Overall, the international credit market plays a vital role in the global financial
system by providing long-term funding to participants and facilitating
international trade and investment activities.
4. International bond market

Ans: The international bond market is a global marketplace where bonds issued
by governments, corporations, and financial institutions are traded. It is an
important part of the global financial system and is used by issuers to raise funds
from investors all over the world.
The international bond market is characterized by long-term borrowing and
lending transactions, usually for periods of more than one year. The bonds traded
in this market include government bonds, corporate bonds, and asset-backed
securities. These bonds are issued by governments, financial institutions, and
corporations to raise funds for various purposes such as funding capital
investments, financing mergers and acquisitions, and refinancing existing debt.
One of the main functions of the international bond market is to provide liquidity
to participants by allowing them to raise funds at a competitive rate. The interest
rates in the international bond market are determined by supply and demand
factors and are influenced by a variety of economic and political events.
The international bond market is also closely linked to the foreign exchange
market, as currency exchange rates play a critical role in determining the cost of
borrowing and lending money in different currencies. Changes in currency
exchange rates can have a significant impact on the international bond market, as
they can affect the cost of servicing debt and the willingness of investors to lend
money.
Overall, the international bond market plays a vital role in the global financial
system by providing long-term funding to participants and facilitating
international trade and investment activities.
5. International Stock markets

Ans: International stock markets refer to the global marketplaces where shares
of publicly traded companies are bought and sold. These markets allow investors
to buy and sell stocks in companies located in countries all over the world,
enabling them to diversify their portfolios and access investment opportunities
beyond their local markets.
There are several major international stock markets, including the New York
Stock Exchange (NYSE) and the Nasdaq in the United States, the Tokyo Stock
Exchange in Japan, the London Stock Exchange in the United Kingdom, the
Shanghai Stock Exchange in China, and the Deutsche Börse in Germany. These
stock exchanges provide a platform for investors to buy and sell shares in
companies listed on their respective markets.
The international stock markets are influenced by a variety of economic, political,
and social factors, such as changes in interest rates, geopolitical events, and
company-specific news. These factors can lead to fluctuations in stock prices and
affect the overall performance of the markets.
In addition to providing investment opportunities, international stock markets
play a critical role in global economic growth and development by facilitating
capital flows between countries and promoting the growth of companies through
access to funding. They also serve as indicators of the health and stability of the
global economy, as changes in stock market performance can provide insights
into broader economic trends.
Overall, the international stock markets are important components of the global
financial system, providing investors with access to a range of investment
opportunities and playing a key role in driving economic growth and development
around the world.
 Chapter: 3 Exchange Rate Determination
1. How exchange rate movements are measured

Ans: Exchange rate movements are typically measured in terms of the value of
one currency in relation to another currency. The exchange rate represents the
price at which one currency can be exchanged for another currency.
There are several ways to measure exchange rate movements:
1) Spot exchange rate: This is the exchange rate for immediate delivery of
currencies, typically within two business days.
2) Forward exchange rate: This is the exchange rate for delivery of
currencies at a future date, typically three, six, or twelve months in the
future.
3) Real exchange rate: This is the exchange rate adjusted for inflation, and
represents the purchasing power of one currency in relation to another
currency.
4) Trade-weighted exchange rate: This is an average of the exchange rates
of a currency against a basket of other currencies, weighted by the volume
of trade between the respective countries.
Exchange rate movements are influenced by a variety of economic, political, and
social factors, such as changes in interest rates, inflation rates, geopolitical events,
and government policies. These factors can cause the value of a currency to
appreciate or depreciate in relation to another currency, leading to fluctuations in
exchange rates.
2. How the equilibrium exchange rate is determined

Ans: The equilibrium exchange rate is the rate at which the supply and demand
for a currency are in balance. It represents the long-term equilibrium point where
the market forces of supply and demand for a currency meet. The equilibrium
exchange rate is determined by a variety of economic factors, including:
1) Relative inflation rates: Countries with higher inflation rates tend to have
a lower value for their currency, as their goods and services become
relatively more expensive compared to countries with lower inflation rates.
 2) Relative interest rates: Countries with higher interest rates tend to attract
foreign investment, increasing demand for their currency and potentially
raising its value.
3) Economic growth: Countries with strong economic growth tend to have a
higher demand for their currency as investors seek opportunities to invest
in growing economies.
4) Trade balance: Countries with a trade surplus tend to have a higher
demand for their currency, as foreign buyers need to purchase their
currency to pay for the goods and services they are importing.
5) Political and economic stability: Countries with political and economic
stability tend to have a higher demand for their currency, as investors see
them as a safe haven and are more likely to invest in them.
The equilibrium exchange rate is not fixed and can change over time as economic
conditions and market forces evolve. Central banks and governments may also
intervene in the market to influence exchange rates, for example by buying or
selling their currency to affect its value relative to other currencies.
Overall, the equilibrium exchange rate represents the balance point where the
forces of supply and demand for a currency are in balance, and is influenced by
a variety of economic, political, and social factors.
3. The factors that affects the equilibrium exchange rate

Ans: The equilibrium exchange rate is the rate at which the supply and demand
for a currency are in balance, and it is influenced by a wide range of economic,
political, and social factors. The following are some of the key factors that affect
the equilibrium exchange rate
1) Inflation: Countries with higher inflation rates tend to have a lower value
for their currency, as their goods and services become relatively more
expensive compared to countries with lower inflation rates.
2) Interest rates: Countries with higher interest rates tend to attract foreign
investment, increasing demand for their currency and potentially raising its
value.
3) Economic growth: Countries with strong economic growth tend to have a
higher demand for their currency as investors seek opportunities to invest
in growing economies.
 4) Trae balance: Countries with a trade surplus tend to have a higher demand
for their currency, as foreign buyers need to purchase their currency to pay
for the goods and services they are importing.
5) Political stability: Political instability can lead to a decrease in demand
for a country's currency, as investors perceive it as a higher risk investment.
6) Government intervention: Governments can influence exchange rates by
buying or selling their currency to affect its value relative to other
currencies.
7) Speculation: Speculators can buy or sell a currency in anticipation of
changes in exchange rates, which can cause the exchange rate to fluctuate.
8) Market sentiment: Public perception of a country's economy, government
policies, or other factors can impact demand for its currency.
Overall, the equilibrium exchange rate is influenced by a complex interplay of
economic, political, and social factors, and it is subject to change over time as
these factors evolve.
Chapter: 4 International Arbitrage and Interest Rate Parity
1. The Conditions that will result in various forms of international Arbitrage.

Ans: International arbitrage refers to the practice of exploiting differences in

the prices of identical or similar financial instruments, goods or services in
different countries, with the aim of making a profit by buying low in one country
and selling high in another country. Here are some of the conditions that can result
in various forms of international arbitrage:
1) Exchange rate differentials: When there are differences in exchange rates
between two countries, it can create opportunities for arbitrage. If the
exchange rate of one country is overvalued compared to another country,
investors can buy the undervalued currency and sell the overvalued
currency in order to profit from the difference.
2) Price differentials: Price differences between the same or similar goods
or services in different countries can also create arbitrage opportunities.
For example, if a particular product is more expensive in one country than
in another, traders can buy the product in the cheaper country and sell it in
the more expensive country to make a profit.
3) Interest rate differentials: Differences in interest rates between two
countries can also create arbitrage opportunities. Investors can borrow
money at a lower interest rate in one country and invest it in another
 country with a higher interest rate, earning the difference in the interest
rates as profit.
4) Regulatory differences: Differences in regulatory environments between
two countries can create arbitrage opportunities. For example, if a
particular financial instrument or investment strategy is legal in one
country but not in another, investors can take advantage of the difference
by investing in the legal country and selling the investment in the illegal
country.
5) Tax differentials: Differences in tax rates between two countries can also
create arbitrage opportunities. If a particular investment or business
activity is taxed less in one country than in another, investors can take
advantage of the difference to minimize their tax liabilities and increase
their profits.
These are just a few of the conditions that can result in various forms of
international arbitrage. Traders and investors must carefully monitor market
conditions and be quick to take advantage of any opportunities that arise.
2. Along with the realignments Arbitrage will occur in response.

Ans: Yes, when there are realignments in the market, arbitrage opportunities
can arise. For example, if there is a sudden change in exchange rates, it can create
an opportunity for traders to buy or sell currencies in different markets to profit
from the difference in prices. Similarly, if there is a sudden change in the price of
a commodity, traders can buy the commodity in a market where it is cheaper and
sell it in a market where it is more expensive.
Arbitrage can also occur in response to realignments in the regulatory
environment, interest rates, or tax policies. For example, if a country increases its
tax rate on a particular investment, it can create an opportunity for investors to
move their investment to another country with a lower tax rate, and potentially
earn a higher return on their investment.
However, it is important to note that arbitrage opportunities are often short-lived,
as traders and investors will quickly move to take advantage of them, which can
cause prices to adjust and erase the arbitrage opportunity. As such, it is important
for traders and investors to act quickly and efficiently to take advantage of
arbitrage opportunities before they disappear.
3. The concept of interest rate parity

Ans: Interest rate parity is a theory that suggests that the interest rate differential
between two currencies should be equal to the difference between the forward
exchange rate and the spot exchange rate. In other words, the expected return on
investing in one currency should be equal to the expected return on investing in
another currency, once the exchange rate differential is taken into account.
The theory of interest rate parity is based on the idea that investors are rational
and will seek to maximize their returns by investing in the currency or asset that
offers the highest return. For example, if the interest rate in one country is higher
than the interest rate in another country, investors will tend to invest in the higher-
yielding currency, which will drive up its value and reduce the expected return.
To take advantage of interest rate parity, investors can use a variety of strategies,
such as carry trades, which involve borrowing in a low-interest-rate currency and
investing in a high-interest-rate currency to earn a positive carry. However, it is
important to note that interest rate parity is not always perfect and can be
influenced by a range of factors, such as changes in economic conditions, political
events, and market sentiment.
Overall, the concept of interest rate parity is an important tool for investors and
traders who are seeking to profit from the differences in interest rates between
currencies. By understanding the principles of interest rate parity and monitoring
market conditions, investors can take advantage of opportunities to earn higher
returns on their investments.
4. How interest rate parity prevents arbitrage opportunities.

Ans: Interest rate parity can help to prevent arbitrage opportunities by ensuring
that the expected returns on investments in different currencies are equalized once
the exchange rate differential is taken into account. This means that if there is an
interest rate differential between two currencies, it will be offset by the expected
change in the exchange rate between those currencies.
For example, if the interest rate in Country A is higher than the interest rate in
Country B, investors may be tempted to borrow money in Country B and invest
it in Country A to earn a higher return. However, the expected appreciation of
Country A's currency versus Country B's currency will reduce the expected return
on the investment, since the investor will have to pay back the borrowed money
in Country B's currency, which will be worth less in terms of Country A's
currency.
In this way, interest rate parity can help to prevent arbitrage opportunities by
ensuring that the expected returns on investments in different currencies are
equalized. If there is a difference between the expected returns, investors will take
advantage of the opportunity to earn a higher return, which will drive up the value
of the currency with the higher interest rate and reduce the expected return.
Overall, interest rate parity is an important concept for understanding how
exchange rates are determined and how arbitrage opportunities can be prevented.
By understanding the principles of interest rate parity, investors and traders can
better understand how changes in interest rates and exchange rates can impact
their investments and trading strategies.
Chapter: 5 Relationships among Inflation, Interest Rate Ans Exchange
Rate
1. The Purchasing Power Parity

Ans: Purchasing power parity (PPP) is a theory that suggests that exchange rates
between two currencies should be at a level that allows the same basket of goods
and services to be purchased in both countries. In other words, PPP suggests that
the exchange rate between two currencies should be adjusted to reflect the
differences in the cost of living between the two countries.
The basic idea behind PPP is that over time, the price of goods and services should
be equalized across countries, once differences in exchange rates and
transportation costs are taken into account. For example, if the cost of a basket of
goods in Country A is higher than in Country B, then the exchange rate between
the two currencies should adjust to reflect this difference, so that a unit of
currency in Country A can buy the same amount of goods as a unit of currency in
Country B.
PPP can be measured in a number of ways, but the most common method is
through the use of the "Big Mac Index," which measures the price of a Big Mac
burger in different countries and compares it to the exchange rate between those
countries.
While PPP is a useful concept in understanding exchange rates and trade between
countries, it is important to note that it is not always perfect and can be influenced
by a range of factors, such as differences in regulations, taxes, and market
conditions. Additionally, PPP may not hold in the short term, as exchange rates
can be influenced by a range of factors, including changes in interest rates,
inflation, and economic growth.
Overall, PPP is an important concept for understanding how exchange rates are
determined and how the cost of living can differ between countries. By
understanding the principles of PPP and monitoring market conditions, investors
and traders can make better-informed decisions about their investments and
trading strategies.
2. International Fisher effect theories.

Ans: The International Fisher Effect (IFE) is a theory that suggests that the
difference in nominal interest rates between two countries should be equal to the
expected change in their exchange rates over a given time period. In other words,
the IFE suggests that changes in interest rates will be offset by changes in
exchange rates, so that the expected returns on investments in different currencies
are equalized.
There are two main theories of the IFE: the covered interest rate parity (CIRP)
and the uncovered interest rate parity (UIRP).
1) Covered interest rate parity (CIRP): CIRP suggests that the difference
in nominal interest rates between two countries should be equal to the
difference in their forward exchange rates. This means that if the interest
rate in one country is higher than in another country, the expected
appreciation of the higher-yielding currency will be offset by the interest
rate differential, so that the expected return on investments in different
currencies is equalized.
2) Uncovered interest rate parity (UIRP): UIRP suggests that the expected
change in the exchange rate between two currencies should be equal to the
difference in their nominal interest rates. This means that if the interest rate
in one country is higher than in another country, the currency with the
higher interest rate is expected to depreciate in value versus the lower-
yielding currency, so that the expected return on investments in different
currencies is equalized.
Both theories of the IFE are important for understanding how changes in interest
rates and exchange rates can impact investments and trading strategies. By
monitoring market conditions and understanding the principles of the IFE,
investors and traders can make better-informed decisions about their investments
and trading strategies.
3. Implications for exchange rate changes of Purchasing power parity

Ans: Purchasing power parity (PPP) suggests that over time, the exchange rate
between two currencies should adjust to reflect the differences in the cost of living
between the two countries. Specifically, PPP suggests that the exchange rate
between two currencies should be such that the same basket of goods and services
costs the same amount in both countries.
If the exchange rate between two currencies is not in line with PPP, there will be
arbitrage opportunities for traders and investors. For example, if the exchange
rate between two currencies is such that a basket of goods and services is cheaper
in one country than in another, traders can buy goods and services in the cheaper
country and sell them in the more expensive country, making a profit from the
difference.
Over time, arbitrage activities will lead to changes in the exchange rate between
the two currencies, such that the cost of the basket of goods and services will be
equalized between the two countries. This means that if a country's inflation rate
is higher than another country's inflation rate, its currency will depreciate in value
against the other country's currency, so that the same basket of goods and services
will cost the same in both countries.
The implications of PPP for exchange rate changes are significant, as it suggests
that exchange rate movements should be driven by differences in inflation rates
between countries. This means that if a country's inflation rate is higher than
another country's inflation rate, its currency should depreciate over time against
the other country's currency, all else being equal. Conversely, if a country's
inflation rate is lower than another country's inflation rate, its currency should
appreciate over time against the other country's currency, all else being equal.
Overall, the PPP theory has important implications for understanding how
exchange rates are determined and how they can change over time. By monitoring
inflation rates and understanding the principles of PPP, investors and traders can
make better-informed decisions about their investments and trading strategies.
4. Implications for exchange rate changes of international Fisher effect
theories

Ans: The International Fisher Effect (IFE) suggests that changes in nominal
interest rates between two countries should be offset by changes in their exchange
rates so that the expected returns on investments in different currencies are
equalized. Specifically, the IFE predicts that if the interest rate in one country is
higher than in another country, the currency with the higher interest rate is
expected to depreciate in value versus the lower-yielding currency, so that the
expected return on investments in different currencies is equalized.
The implications of the IFE for exchange rate changes are significant, as it
suggests that interest rate differentials can influence the exchange rate between
two currencies over time. For example, if the interest rate in one country increases
relative to another country, investors are more likely to invest in that country,
which can cause an increase in demand for the currency and an appreciation of
its value.
However, it is important to note that the IFE is a theory that assumes a number of
factors remain constant, such as inflation rates and risk premiums. In reality, there
are many other factors that can influence exchange rates, including political
events, economic indicators, and market sentiment. Therefore, while the IFE
provides a useful framework for understanding the relationship between interest
rates and exchange rates, it is not always accurate and should be used in
conjunction with other economic and market indicators.
Overall, the IFE theory has important implications for understanding how interest
rate differentials can impact exchange rates and the expected returns on
investments in different currencies. By monitoring interest rates and
understanding the principles of the IFE, investors and traders can make better-
informed decisions about their investments and trading strategies.
5. Compare the Purchasing power parity & International Fisher effect
theories

Ans: Purchasing power parity (PPP) and the International Fisher Effect (IFE)
are both economic theories that relate to exchange rates and their determination.

PPP suggests that the exchange rate between two currencies should adjust to
reflect the differences in the cost of living between the two countries. Specifically,
PPP suggests that the exchange rate between two currencies should be such that
the same basket of goods and services costs the same amount in both countries.
This theory suggests that over time, exchange rate changes should be driven by
differences in inflation rates between countries.
On the other hand, the IFE suggests that changes in nominal interest rates between
two countries should be offset by changes in their exchange rates so that the
expected returns on investments in different currencies are equalized.
Specifically, the IFE predicts that if the interest rate in one country is higher than
in another country, the currency with the higher interest rate is expected to
depreciate in value versus the lower-yielding currency, so that the expected return
on investments in different currencies is equalized.
While both PPP and the IFE are theories that relate to exchange rates, they differ
in their focus and assumptions. PPP is primarily concerned with differences in the
cost of living and inflation rates between countries, while the IFE is concerned
with interest rate differentials and their impact on exchange rates. Additionally,
the IFE assumes that other factors remain constant, such as inflation rates and risk
premiums, while PPP assumes that differences in inflation rates will drive
exchange rate changes over time.
Overall, both PPP and the IFE are useful tools for understanding exchange rate
determination and can be used by investors and traders to make better-informed
decisions about their investments and trading strategies.
6. Compare the Purchasing power parity, International Fisher effect
theories, Interest rate parity.

Ans: Purchasing Power Parity (PPP), International Fisher Effect (IFE) and
Interest Rate Parity (IRP) are all economic theories that relate to exchange rates
and their determination.
PPP suggests that exchange rates between two currencies should adjust to reflect
the differences in the cost of living between two countries. This theory predicts
that exchange rates should be driven by differences in inflation rates between
countries, and that over time, exchange rate changes should adjust to equalize the
cost of living between two countries.
The IFE suggests that differences in nominal interest rates between two countries
should be offset by changes in their exchange rates so that the expected returns
on investments in different currencies are equalized. This theory predicts that if
the interest rate in one country is higher than in another country, the currency with
the higher interest rate will depreciate in value versus the lower-yielding currency,
so that the expected return on investments in different currencies is equalized.
The IRP theory suggests that the difference in interest rates between two
currencies should be equal to the difference in their forward exchange rates,
taking into account any risk premiums. In other words, the IRP theory predicts
that the interest rate differential between two currencies should be offset by the
difference in their forward exchange rates.
Overall, while each of these theories is focused on exchange rate determination,
they differ in their assumptions and focus. PPP focuses on differences in the cost
of living, while IFE focuses on interest rate differentials, and IRP focuses on the
relationship between interest rates and forward exchange rates. Despite their
differences, all three theories provide useful frameworks for understanding
exchange rate determination and can be used by investors and traders to make
informed decisions about their investments and trading strategies.