Relationship Between Purchasing Power Parity, International Fisher Effect and Derivatives

Explain  why  PPP  and  IFE  in  theory  makes  derivatives     unnecessary.
2. Evaluate  the  differing  ways  in  which  derivatives  can  protect     against  the  failings  of  IFE  and  PPP.  

Please  read  the  following  5  items:    

1.   Parts  b(i)  and  b(ii)  carry  equal  marks  but  the  word  count   is  for  the  whole  of  part  b.

2.   Clearly  indicate  which  part  you  are  answering  by  quoting   the  EXACT  titles  “b(i)  Explain…unnecessary”  and  “b(ii)   Evaluate  …PPP”.  
3.   The  lecture  slides  should  be  used  as  the  basis  of  your   answer.  
4.   Words  that  are  not  your  own  must  be  in  inverted  commas   and  clearly  referenced  directly  after  the  inverted  commas   giving  author  name,  year  of  publication  and  page  number   of  the  publication.  Further  details  should  be  given  at  the   end  of  your  submission  under  the  title  “References”.  
5.   Referencing  is  not  encouraged,  your  understanding  of  the   course  material  and  your  ability  to  present  a  well   explained  argument  in  your  own  words  based  on  the   course  material  is  the  most  important  consideration  in   assessing  your  submission.      

6.   You  are  allowed  200  words  over  the  2,000  to  cover  for  all   items  considered  as  extra  to  the  content  of  your  answer.   (2,000  words;;  70%)  

According to the Purchasing power parity, otherwise called the theory of interest rate parity, when two countries have the same purchasing power, there exists an equilibrium in the rate of exchange (IMF, 1976). Ideally, it implies that the exchange ratio rate to that of the level of price per service or a bag of goods between the two countries is the same. This theory gives us the ability to predict or project the rates of exchange in the future. In its approach, the theory relies on the relationship between inflation and the rate of exchange. In its statement, IFE projected the current rate between two given currencies will have a direct relationship to the disparity between the nominal rate of interest of the nations at a particular time.

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