Risk Management Report: School House, UK Market Entry & PPP

This report focuses on risk management, specifically addressing the challenges faced by School House, a US-based fashion house, as it plans to expand into the UK market. The primary issue discussed is the pricing system, necessitating an understanding of the Purchasing Power Parity (PPP) theory to conduct business in pounds. The report explains PPP as a macroeconomic tool used to compare economic productivity and living standards between countries, highlighting its role in exchange rate determination. It explores how PPP can be used to forecast future exchange rates and provides insights into how School House can use the PPP model, including the Big Mac Index, to understand pricing structures and profit margins, even considering factors like quality control and exchange rate fluctuations. The report references several academic sources to support its analysis.

Running head: RISK MANAGEMENT
RISK MANAGEMENT
Name of the Student:
Name if the University:
Author Note:

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School House, a USA based fashion house, is taking an endeavour to shift to and expand over
the UK market. Founder Rachel Weeks, started her journey from Sri Lanka, and after
observing a successful business in America the country is now trying to strive out to UK.
However, while planning for the movement, the country is coming across certain issues, like
issues with the freight and duty, the shipment timing, the quality control approach and the
like. However, the most important thing that the organization is faced with, is the pricing
system. Since the organization have to include the pricing structure in pounds, therefore, they
are problems in understanding the criteria for a business conduct in pounds, and therefore, is
in need of understanding the Power Parity Theory.
Purchasing Power Parity Theory (PPP):
Purchase parity theory is one of the most dominant macroeconomic analysis metric that is
used to compare and analyse the economic productivity and the standards of living of a
particular country. The Purchasing power parity is an economic theory that reflects upon the
economic relations between two countries, and compares between the currencies of two
country, and in order to that it includes the approach of “basket of goods” (Chen & Tsang,
2013). Many countries often seen to have managing their Gross Domestic Product in order to
figure and manage their PPP.
PPP as a Theory of Exchange Rate Determination:
The PPP can be considered as a determinant of the theory of exchange rate determination, as
it includes the behaviour of the importers and exporters in reaction to the relative costs of the
national market baskets. The basic notion of the theory is that when a product from a low
price economy market is sole at a higher price economy market, then a profit is expected.
Now, if the two prices are almost equalised for two certain markets, then it is expected that
the PPP will also get held, describing the quality of the two market baskets (Noussair Plott &
Riezman, 22013). This is the one price theory of PPP. Now there is another aspects, that the

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profit structure will be affected by the exchange rates that will be involved in these two
different markets.
Now, as according to the equilibrium approach of the theory it can be stated that the cheaper
basket of US will increase the demand for the goods, and as a consequence it is likely to
increase the price of the US Dollar in the market, therefore, as a result, the price of the Dollar
will increase in the exchange market, therefore, with the increased demand, and thus, profit is
expected.
If you assume PPP holds, could it help in forecasting the future exchange rate of
the British pound?
The PPP model is considered to be one of the most important theory to describe and forecast
the future of the market and the future of the exchange rate. The theoretical approach of law
of one price, states that the identical goods from different countries should have an identical
price. As it will decrease the chances of arbitrage opportunities for a person to buy an
inexpensive pencil in one country, and then sell it in a different country, thus, gaining a
profit. This particular approach also helps the model to reflect upon the inflation that can be
perceived in the country. The theory states that as with the charges in the exchange rates to
offset price changes there is likely to be an inflation as according to the principle (Engel &
Mark, 2015). For example, if the price of a pencil in America is expected to be increasing at a
rate of 4%, then as according to the current pricing structure, the expected price hike of the
pencil in Canada will be, only 2%. And the inflation differential between these two countries
will be,
4% - 2% = 2%

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Therefore, the prices of the pencil in America is expected to be rising faster than Canada, and
therefore, if the prices can be calculated, then the future pricing structure of both the
companies can be easily understood and analysed.
Similarly, for the company School House, to understand about the pricing structure and to
understand the profit margin, they can include the PPP model and further develop upon that.
The PPP model will also enable the company to understand about the future mart, and how
can they make a good profit, even after considering the issues related to quality control and
the issues reacted to exchange rates. The organization can also include in their approach the
Big Mac Index, related to the PPP model, which will enable them to understand whether the
considered price for a particular product is undervalued or overvalued (Frenkel & Johnson,
2013).

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References:
Chen, Y. C., & Tsang*, K. P. (2013). What does the yield curve tell us about exchange rate
predictability?. Review of Economics and Statistics, 95(1), 185-205.
Engel, C., Mark, N. C., & West, K. D. (2015). Factor model forecasts of exchange
rates. Econometric Reviews, 34(1-2), 32-55.
Frenkel, J. A., & Johnson, H. G. (2013). The Economics of Exchange Rates (Collected Works
of Harry Johnson): Selected Studies. Routledge.
Noussair, C. N., Plott, C. R., & Riezman, R. G. (2013). The principles of exchange rate
determination in an international finance experiment. In International Trade
Agreements and Political Economy (pp. 329-368).