Describe the various theories of Exchange Rate Determination. Differentiate between Nominal and Effective Exchange Rate. Discuss the factors impacting exchange rates.

Exchange rate determination refers to the factors that influence the value of one currency relative to another. Several theories help explain how exchange rates are set, each with its own approach. These theories include the Purchasing Power Parity (PPP), the Interest Rate Parity (IRP), the Balance of Payments (BOP) theory, and the Monetary Model.

1. Purchasing Power Parity (PPP)
   The PPP theory suggests that exchange rates adjust to equalize the price of identical goods and services in different countries, once converted to a common currency. According to this theory, if the price level of a basket of goods in one country rises relative to another, the currency of the higher-price country should depreciate in order to restore the parity between the two countries' currencies. This approach assumes no trade barriers, perfect competition, and mobility of goods across borders.

2. Interest Rate Parity (IRP)
   The IRP theory posits that the exchange rate between two currencies should reflect the difference in their interest rates. If a country's interest rate is higher than that of another, capital flows will tend to move towards the higher-interest country, causing its currency to appreciate. The theory holds that the forward exchange rate (the rate agreed upon for future transactions) will adjust to ___ __________ ____ ______ _________ _____ _____ ______ _____ ________ ___ _________.
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