Question

Explain the following (with Example)

a. Interest Rate Parity

b. Purchasing Power Parity

Answer 1

Solution:

a.). Interest rate parity is a no-arbitrage condition that represents an equilibrium state in which investors can obtain interest rates on bank deposits in two different countries.

Interest rate parity (IRP) connects interest rates, spot exchange rates, and foreign exchange rates in foreign exchange markets.

 

b.). Purchasing Power Parity is the measurement of prices in different countries that uses the prices of specific goods to compare the absolute purchasing power of the countries' currencies.

Purchasing power parity (PPP) is a popular macroeconomic metric that compares the currencies of different countries using a "basket of goods" approach.

Purchasing power parity (PPP) allows economists to compare economic productivity and living standards across countries.