Purchasing power parity and international fisher effect

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Reference no: EM132070350

There are three theories that explain exchange rate behaviour, two of these deals with how inflation rates affect the exchange rate. They are purchasing power parity (PPP) and International Fisher Effect (IFE).

(a) In reality, PPP does not hold. Even PPP holds, this does not consistently occur. Give two major reasons why PPP does not hold consistently. Explain in detail.

(b) Assume the spot exchange rate of Singapore dollar to US dollar is US$0.7420/S$. The one-year interest rate is 0.3% in U.S. and 6% in Singapore. What would be the spot rate in one year according to IFE?

Reference no: EM132070350

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