Justification of Volatility of Foreign Exchange Rates given PPP and UIP

Running Head: INTERNATIONAL FINANCE
INTERNATIONAL FINANCE
Name of the Student
Name of the University
Author Note

1INTERNATIONAL FINANCE
Table of Contents
Justification of Volatility of Foreign Exchange Rates given PPP and UIP...............................2
Purchasing Power Parity............................................................................................................2
Uncovered Interest Parity...........................................................................................................2
Volatility of Exchange Rates and Relation with PPP or UIP or both........................................3
Devaluation of Pound against other major currencies...............................................................5
Shocks to Other Currencies........................................................................................................5
Econometric approach................................................................................................................7
Reference....................................................................................................................................8

2INTERNATIONAL FINANCE
Justification of Volatility of Foreign Exchange Rates given PPP and UIP
The aim of the assignment is the analysis on the international finance. The analysis
will be based on the conditions of the exchange rate equilibrium conditions of Purchasing
Power Parity and Uncovered Interest Parity. In addition, dicussion will also be based on the
justification of the high levels of the volatility in the foreign exchang rates . Volatility of the
exchange rates makes the international trade as well as decisions of investments much more
difficult beacause the volatility increases the risk of exchange rate (Grossmann, Love and
Orlov 2014).
Purchasing Power Parity
It is the theory of economy which compares the currencies of the different countries
through the approach of the “basket of goods”. It is concerned with the concept of the
equilibrium of the two currencies that is at par when the price of the basket of goods is same
for both the countries that takes the account of the exchange rates. Hence, it is the way of the
measurement of the economic variables in the different countries for which the there is
variations of the irrelevant exchange rate does not distort the comparison. This rate is
required in the comparisons of that is equal to the ratio of respective purchasung power of the
currencies (Jolliffe and Prydz 2015).
Uncovered Interest Parity
This theory defines the interest rates differences between the two countries that is
equal to the currency of the foreign exchange rate’s relative change over the same time frame.
It is the form of the interest rate parityh that is used besides the covered interet rate parity.
The conditions of the uncovered interest rate parity is consists with the two streams of return,
one is from the investment’s interest rate of foreign money market as well as other from the
changes in the spot rate of foreign currency(Lothian 2016).