What do you understand by Purchasing Power Parity (PPP) and Interest R

Question

What do you understand by Purchasing Power Parity (PPP) and Interest Rate Parity? Explain the reasons for deviation of these parity conditions.

26 Oct 2021

Answer :

Word Count : 572

Purchasing Power Parity (PPP):

Purchasing Power Parity (PPP) is a theory in international financial management that suggests that exchange rates between two currencies should equalize the relative prices of a basket of identical goods and services in each country. In other words, under PPP, the exchange rate between two currencies should reflect the adjustments needed for the cost of living and inflation rates in both countries, ensuring that a unit of currency has the same purchasing power in different nations.

The formula for PPP is:

\[ \text{Exchange Rate} = \frac{\text{Price level in the foreign country}}{\text{Price level in the home country}} \]

There are two versions of PPP: absolute PPP and relative PPP. Absolute PPP _____ __________ __________ ____ ___ _____ _____ _________ ______.
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