• # Research Paper on:Forecasting Exchange Rates Using PPP and IRP

Number of Pages: 4

## Summary of the research paper:

This 4 page paper uses the purchasing power parity (PPP) and the interest rate parity (IRP) to calculate possible future exchange rates of Sterling against the dollar. The models are explained and the calculations shown. The paper ends by assessing the validity and potential accuracy of these models. The bibliography cites 3 sources.

Name of Research Paper File: TS65_TEPPPIRP.doc

Unformatted Sample Text from the Research Paper:
vary depending on the way that the exchange rate is expected to move, with the home currency depreciating or appreciating against the foreign currencies. A number of theories have  been developed that help to explain some, if not all, the exchange rate movements that may be observed. Two of the main models which are used are the purchasing  power parity (PPP) and the interest rate parity (IRP). To assess the way the British Pound (Sterling) may move in the next year each of the models will be  used and then each method will be discussed to assess which is believed to be the most accurate. The calculations will be based on figures provided by the student which  make assumptions regarding the rates of inflation, interest rate and exiting spot rate for the home and the foreign county. The purchasing power parity is also referred to as the  inflation theory of exchange rates and is based on no arbitrage argument or the law of one price, with the underlying basis that good will have the same equivalent cost  in each nation. Therefore, the changes in prices of the goods will impact on the exchange rate. In very simply terms if one country has an inflation rate that is  5% greater than the other, the country with the highest inflation rate will see their currency depreciate by level of inflation that is greater than the comparator. Therefore, the country  with the lower rate of inflation will see their currency appreciate. There is an equitation which may be used to calculate the impact on the exchange rate as long  as the current spot rate and the expected inflation rates are known for the two countries. The equation is FR = SRx(1 +Inhc)/(1+Infc) In this equation FR = Future