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Unformatted text preview: EC 340 Final Exam Review • As a currency APPRECIATES, its products become more expensive abroad, and foreign products become less expensive at home. Home firms become less expensive. And vice versa • Absolute purchasing power parity- in the long run, exchange rates between 2 countrieswill show the level of prices compared to domestic prices. If EX fc/$ - EXfc/$(long run) is negative it is undervalued. If it is positive then it is overvalued. • Relative purchasing power parity- change in exchange rate reflects the change in prices. Inflation rate= change in prices % change in EX fc/$ = foreign inflation- US inflation • Interest Rate is a short r un determinant of exchange rate. • Uncovered foreign investment= interest rate of foreign country x ( change in EX$/f/EX$/f) • Hedging- currency swap. I t is a transaction to avoid risk • Interest rate parity formula =(FX-EX) F/$ / EX f/s = interest rate foreign - interest rate US Negative= discount and positive= premium • Basic principle- country with a lower interest rate has its currency...
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This note was uploaded on 04/30/2008 for the course ECON 340 taught by Professor Leidholm during the Spring '08 term at Michigan State University.
- Spring '08
- Purchasing Power Parity