5362.2a_note, 11S
FIN 536 – SU
Page 1 of 7
Topic 2.2 International Parity Conditions (Chapter 7)
I.
Outline
A.
Introduction: Inflation
B.
Parity Condition
1.
PPP
2.
FE
3.
IFE
4.
IRP
5.
UFH
II.
Homework Assignment
Chapter
7
EndofChapter Question
EndofChapter Problem (P)
7, 8, 14, 18
Exam Sample Problem (ES)
19
Supplementary Homework Problem
(SH)
12
=========================================================
Class Notes
I.
Link 2: Inflation and Interest Rate – The Fisher Effect (FE)
A.
Review on Interest rate
1.
Different Interest rates
Time Line
Nominal Rate
(I
NOM
)
Periodic Rate
(I
PER
)
Effective Annual Rate
(I
EFF
)
Example:
10% annual
compounding
Example:
10%
semiannual
compounding
Example:
10% Quarterly
compounding
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FIN 536 – SU
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2.
Interest Rate Example:
An investor receives $1100 in one year in return for an investment of
$1000 now.
What is the nominal rate under the following scenarios?
Time Line
Nominal Rate (I
NOM
)
Periodic Rate (I
PER
)
Effective Annual
Rate (I
EFF
)
Annual
compounding
Semiannual
compounding
Quarterly
compounding
B.
The nominal interest rate will include two components:
1.
A real return rate that increases the purchasing power of the loaned funds
2.
A return that offsets the loss of purchasing power due to expected inflation.
C.
FE Example: Find the real interest rate
r (Nominal interest rate)
a (real interest rate)
π
(inflation rate)
US
2%
1.5%
UK
5%
4.5%
D.
Exact form
E.
Approximate form
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 Spring '11
 Staff
 Inflation, Interest Rates, International Finance, Forward rate

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