This is the text-only version of this week s content. Note: All media (i.e., videos, PowerPoints, and Flash presentations) and learning activities (i.e., assigned readings, assignments, and discussions) are accessible only through the online course. Week 5: Relationships Among Inflation, Interest Rates, and Exchange Rates Overview (1 of 2) Transcript: Welcome back to W eek Five of International Financial Management, this week ends with the second exam. The exam will cover all material covered in the course but with greater emphasis on W eeks Four and Five. The material covered this week will be about relationships among inflation, interest rates and exchange rates. In Lesson One we ll learn the relation between inflation and exchange rates, purchasing power parity theory describes this relation, it s a theory based on trade. W e ll learn the implications of purchasing power parity for exchange rate changes over time. For example, countries with high inflation will see their currency depreciate. At this point you may wish to go back to W eek Two to refresh your skills in calculating a percentage change in an exchange rate. W e ll then use linear regression to test the purchasing power parity theory, at this point you may wish to go back to Week One to refresh your linear regression skills. In Lesson Two we ll learn the relation between interest rates and exchange rates. The theory, the international fisher effect is a theory based on purchasing power parity. You ll learn the implications of the international fisher effect for exchange rate changes over time. W e ll use linear regression to test the theory. By the end of the week, you ll understand the purchasing power parity theory. You ll understand the international fisher effect theory. You ll understand the implications of the theory for exchange rate changes over time. You ll understand how to test purchasing power parity and how to test the international fisher effect theory using linear regression and most important you ll be able to appropriately interpret regression results. At the end of this week you ll have exam two. Also this week there is one graded assignment, the Turkish Lira mini-case. Overview (2 of 2) Inflation and interest rates can have a significant impact on exchange rates and therefore can affect the value of MNCs. MNC financial managers must understand how inflation and interest rates can affect interest rates so that they can anticipate how their MNCs may be affected. Given their potential influence on MNC values, inflation and interest rates are studied more closely in Lessons 1 and 2 of this week. The first lesson of this week discusses the relation between inflation and exchange rates. Purchasing Power Parity (PPP) theory provides an explanation for the inflation-exchange rate relation. In particular, PPP explains the relation between inflation (home country inflation relative to foreign country inflation) and the change in the exchange rate for the foreign currency over time. The second lesson of this week discusses the relation between interest rates and exchange rates. The international Fisher effect (IFE) - 1 -
theory provides an explanation for the interest rate-exchange rate relation. In particular, IFE explains the relation between interest rates (the home country interest rate relative to the foreign country interest rate) and the change in the exchange rate for the foreign currency over time. In W eek 2, we learned how to calculate the percentage change in an exchange rate. In W eek 1, we learned how to apply linear regression to finance. Both of these skills will be utilized in both Lesson 1 and Lesson 2 this week. In gathering our data, we will need to be able to calculate the percentage change in an exchange rate. Then to test the PPP and IFE theories, we will take the data and perform statistical tests. Learning Objectives At the completion of this week, you will be able to: 1. Explain the theory of Purchasing Power Parity (PPP). 2. Explain the implications of PPP for exchange rate changes over time. a. Calculate the percentage change in the exchange rate implied by PPP. 3. Derive PPP. 4. Understand the graphic analysis of PPP. 5. Use linear regression to test the PPP theory. 6. Explain why PPP may not occur. 7. Explain the International Fisher Effect (IFE) theory. 8. Understand the implications of IFE for investors. 9. Derive IFE. a. Calculate the percentage change in the exchange rate implied by IFE. 10. Understand the graphic analysis of IFE. 11. Use linear regression to test the IFE theory. 12. Explain why PPP may not occur. 13. Compare Interest Rate Parity, PPP, and IFE. Learning Activities Learning Activity Description Due Date % of Final Grade Lesson 1 The Relationship Between Inflation and Exchange Rates: PPP Complete by end Day 1 ~ Reading 1 Chapter 8, pp. 241-250 from Textbook Complete by end Day 1 ~ Week 5 Assignment 1 Week 5 Discussion 1 Turkish Lira Mini-Case and Purchasing Power Parity Turkish Lira Mini-Case and Purchasing Power Parity Submit by end Day 3 5% Optional ~ - 2 -
Lesson 2 The Relationship Between Interest Rates and Exchange Rates: IFE Complete by end Day 4 ~ Reading 2 Chapter 8, pp. 250-261 from Textbook Complete by end Day 4 ~ Preparation for Exam 2 study questions to prepare for the exam. Complete by end Day 3 ~ Exam 2 Complete the exam and then submit your calculation document on the Exam 2 Calculations page. Opens 7:00 a.m. E.T. Day 4 Closes e n d o f Day 7 30% Lesson 1: The Relationship Between Inflation and Exchange Rates: PPP Introduction This lesson provides a discussion of the relation between inflation and exchange rates. Purchasing Power Parity (PPP) theory quantifies the inflation-exchange rate relation. The idea behind the theory is that if a foreign country is experiencing higher inflation than the home country, goods produced in the foreign country become more expensive relative to goods produced in the home country. Imports of the now more expensive foreign goods decrease; demand for the foreign currency decreases. Exports of the relatively less expensive domestic goods increase; the supply of foreign currency increases. Both effects suggest that the foreign currency will depreciate. Thus, if the foreign country has higher inflation, the foreign currency depreciates. Depreciation of the foreign currency makes the foreign goods less expensive when measured in the home country currency. Thus, the depreciation of the foreign currency offsets the greater inflation (higher prices measured in the foreign currency) in the foreign country. The absolute form of PPP suggests that the prices of the same basket of goods in two different countries should be equal when measured in a common currency. Realistically, however, transportation costs and barriers to trade may prevent the absolute form of PPP. The relative form of PPP accounts for market imperfections such as transportation costs and barriers to trade. The relative form of PPP suggests that the rate of change in the prices of goods should be the same when measured in a common currency. Given market imperfections, PPP suggests that exchange rates adjust in response to the inflation differential across countries. The percentage change in the exchange rate over time should equal the inflation differential. Linear regression can be used to test this relation, where the percentage change in the exchange rate is the dependent variable and the inflation differential is the independent variable. Learning Objectives At the completion of this lesson, you will be able to: 1. Explain the theory of Purchasing Power Parity (PPP). - 3 -
2. Explain the implications of PPP for exchange rate changes over time. a. Calculate the percentage change in the exchange rate implied by PPP. 3. Derive PPP. 4. Understand the graphic analysis of PPP. 5. Use linear regression to test the PPP theory. 6. Explain why PPP may not occur. Reading 1 (Complete by the end of Day 1) The eighth chapter in the Madura text begins with a discussion of the relation between inflation and exchange rates. Purchasing Power Parity theory explains how an exchange rate changes in response to differential inflation between two countries. Read the following in the Madura text: Chapter 8, pp. 241-250 Purchasing Power Parity (PPP) PPP quantifies the inflation-exchange rate relation. When one country's inflation rate rises relative to that of another country, decreased exports and increased imports depress the country's currency. The theory of purchasing power parity (PPP) attempts to quantify this inflation - exchange rate relationship. The absolute form of PPP, or the "law of one price," suggests that similar products in different countries should be equally priced when measured in the same currency. The relative form of PPP accounts for market imperfections like transportation costs, tariffs, and quotas. It states that the rate of change in prices of similar products in different countries should be the same when measured in the same currency. Rationale Behind the PPP Theory Inflation affects relative prices, which affect trade, which affects the exchange rate. Suppose U.S. inflation > U.K. inflation. This implies an increase in U.S. imports from the U.K. and a decrease in U.S. exports to the U.K., so the appreciates. This shift in consumption and the appreciation of the will continue until: in the U.S., price U.K. goods price U.S. goods, & in the U.K., price U.S. goods price U.K. goods. Derivation of PPP (1 of 3) If PPP holds, the change over time in prices paid by home country consumers for goods produced in the home country should equal the prices paid by home country consumers for goods produced in the foreign country. - 4 -
Assume that PPP holds. Over time, inflation occurs and the exchange rate adjusts to maintain PPP: Over time, prices for domestic goods adjust: o P h becomes P h (1 + I h ) Where: P h = home country's price index I h = home country's inflation rate Over time, prices for imported goods adjust: P f becomes P f (1 + I f ) (1 + e f ) Where: P f = foreign country's price index I f = foreign country's inflation rate e f = foreign currency's % Δ in value Note: Recall that in W eek 2 Lesson 2 (Madura Chapter 4), we learned how to calculate the percentage change in the value of a foreign currency, e f Derivation of PPP (2 of 3) If PPP holds then: P h = P f P h (1 + I h ) = P f (1 + I f ) (1 + e f ) Solving for e f : e f = (1 + I h ) (1 + I f ) - 1 If I h > I f then e f > 0, the foreign currency appreciates If I h < I f then e f < 0, the foreign currency depreciates Example Suppose I U.S. = 9% and I U.K. = 5%. Then: e U.K. = (1 +.09 ) (1 +.05 ) - 1 = 3.81% - 5 -
When I f is less than 10%, the PPP relationship can be approximated as: e f I h - I f Derivation of PPP (3 of 3) Example Suppose I U.S. = 9% and I U.K. = 5%. Then: e U.K. 9% - 5% = 4% U.S. consumers: Δ P U.S. = I U.S. = 9% Δ P U.K. = I U.K. + e U.K. = 9% U.K. consumers: Δ P U.K. = I U.K. = 5% Δ P U.S. = I U.S. - e U.K. = 5% P U.S is the change in the price over time for American goods. P U.K is the change in the price over time for goods produced in the U.K. The change in the price in dollars (what U.S. consumers use to pay for goods) is not the same as the change in price in pounds (what U.K. consumers use to pay for goods). However, PPP does suggest that the change in prices for U.S. and U.K. goods measured in dollars should be the same (9% in this example) and the change in prices for U.S and U.K goods measured in pounds should be the same (5% in this example). Graphic Analysis of PPP PPP holds along the diagonal line, where the percentage change in the exchange rate equals the inflation differential. Log in to the course to view the graph that supports this section. Increased purchasing power for foreign goods means that, measured in the home country currency, the increase in the price for foreign goods is less than the increase in the price for domestic goods. Decreased purchasing power for foreign goods means that, measured in the home country currency, the increase in the price for foreign goods is greater than the increase in the price for domestic goods. - 6 -
Testing the PPP Theory Linear regression is used to test the PPP theory. Conceptual Test Plot the actual inflation differential and exchange rate % change for two or more countries on a graph. If the points deviate significantly from the PPP line over time, then PPP does not hold. Statistical Test Apply regression analysis to the historical exchange rates and inflation differentials: o e f = a 0 + a 1 { (1+I h )/(1+I f ) - 1 } + µ The appropriate t-tests are then applied to a 0 and a 1, whose hypothesized values are 0 and 1 respectively. The hypothesized value for a 0 is that a 0 is equal to 0. The hypothesized value for a 1 is that a 1 is equal to 1. If you can reject either of the two null hypotheses, then you have evidence inconsistent with PPP theory. If you cannot reject either of the two null hypotheses, then you can conclude that you do not have evidence inconsistent with PPP theory. Note: Recall that in W eek 1, we reviewed linear regression. You will need to apply that knowledge here. Empirical Tests of the PPP Theory and Why PPP Does Not Occur Empirical studies do not support the PPP theory even in the long run. This is most likely because other factors also affect exchange rates. Empirical studies indicate that the relationship between inflation differentials and exchange rates is not perfect even in the long run. However, the use of inflation differentials to forecast long-run movements in exchange rates is supported. - 7 -
PPP may not occur consistently due to: Confounding effects, and Exchange rates are also affected by differentials in interest rates, income levels, and risk, as well as government controls. Lack of substitutes for traded goods. Exercise The following questions are from the end of Chapter 8 in your course text. Question: PPP Explain the theory of purchasing power parity (PPP). Based on this theory, what is a general forecast of the values of currencies in countries with high inflation? PPP suggests that the purchasing power of a consumer will be similar when purchasing goods in a foreign country or in the home country. If inflation in a foreign country differs from inflation in the home country, the exchange rate will adjust to maintain equal purchasing power. Currencies in countries with high inflation will be weak according to PPP, causing the purchasing power of goods in the home country versus these countries to be similar. Question: Testing PPP Inflation differentials between the U.S. and other industrialized countries have typically been a few percentage points in any given year. Yet, in many years annual exchange rates between the - 8 -
corresponding currencies have changed by 10 percent or more. W hat does this information suggest about PPP? The information suggests that there are other factors besides inflation differentials that influence exchange rate movements. Thus, the exchange rate movements will not necessarily conform to inflation differentials, and therefore PPP will not necessarily hold. Question: Interpreting Inflationary Expectations If investors in the United States and Canada require the same real interest rate, and the nominal rate of interest is 2 percent higher in Canada, what does this imply about expectations of U.S. inflation and Canadian inflation? W hat do these inflationary expectations suggest about future exchange rates? Expected inflation in Canada is 2 percent above expected inflation in the U.S. If these inflationary expectations come true, PPP would suggest that the value of the Canadian dollar should depreciate by 2 percent against the U.S. dollar. Question: PPP Japan has typically had lower inflation than the United States. How would one expect this to affect the Japanese yen's value? Why does this expected relationship not always occur? Japan's low inflation should place upward pressure on the yen's value. Yet, other factors can sometimes offset this pressure. For example, Japan heavily invests in U.S. securities, which places downward pressure on the yen's value. Question: Estimating Depreciation Due to PPP Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 2 percent? According to PPP, the exchange rate of the pound will depreciate by 4.7 percent. Therefore, the spot rate would adjust to $1.73 [1 + (-.0467)] = $1.649. - 9 -
Question: Implications of PPP Today's spot rate of the Mexican peso is $.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7%, while the Mexican inflation over this year is expected to be 3%. W ake Forest Co. plans to import from Mexico and will need 20 million Mexican pesos in one year. Determine the expected amount of dollars to be paid by the W ake Forest Co. for the pesos in one year. [(1.07)/(1.03)] - 1 = 3.8835%. So the expected future spot rate is $.1038835. Carolina will need to pay $.1038835 20 million pesos = $2,077,710. Summary With the completion of this lesson, you should understand the Purchasing Power Parity (PPP) theory, be able to explain the implications of PPP for exchange rate changes over time, derive PPP, and analyze and test PPP theory. You will need to be able to perform a statistical test (linear regression). You should also be able to interpret your regression results; this means that you should be able explain the statistical significance of your results and state whether your results are consistent or inconsistent with the theory. Log in to the course to access the PowerPoint file for this lesson. Lesson 2: The Relationship Between Interest Rates and Exchange Rates: IFE Introduction The eighth chapter in the Madura text continues with a discussion of the relation between interest rates and exchange rates. The International Fisher Effect (IFE) theory quantifies the interest rate-exchange rate relation. Since interest rates are related to inflation, the IFE theory is based on the PPP theory; IFE is related to PPP. IFE suggests that exchange rates adjust in response to the interest rate differential across countries. The percentage change in the exchange rate over time should equal the interest rate differential. Linear regression can be used to test this relation, where the percentage change in the exchange rate is the dependent variable and the interest rate differential is the independent variable. Learning Objectives At the completion of this lesson, you will be able to: 1. Explain the International Fisher Effect (IFE) theory. 2. Understand the implications of IFE for investors. 3. Derive IFE. a. Calculate the percentage change in the exchange rate implied by IFE. 4. Understand the graphic analysis of IFE. 5. Use linear regression to test the IFE theory. - 10 -
6. Explain why PPP may not occur. 7. Compare Interest Rate Parity, PPP, and IFE. Reading 2 (Complete by the end of Day 4) The second part of the eighth chapter in the Madura text contains a discussion of the relation between interest rates and exchange rates. The International Fisher Effect theory explains how an exchange rate changes in response to interest rate differentials. Read the following in the Madura text: Chapter 8, pp. 250-261 International Fisher Effect (IFE) The IFE theory is based on the PPP theory. The IFE quantifies the interest rate-exchange rate relation. According to the Fisher effect, nominal risk-free interest rates contain a real rate of return and an anticipated inflation. If the same real return is required, differentials in interest rates may be due to differentials in expected inflation. According to PPP, exchange rate movements are caused by inflation rate differentials. The international Fisher effect (IFE) theory suggests that currencies with higher interest rates will depreciate because the higher rates reflect higher expected inflation. Hence, investors hoping to capitalize on a higher foreign interest rate should earn a return no better than what they would have earned domestically. The Implications of the IFE The IFE theory suggests that investing in the money market abroad will result in the same rate of return, on average, as investing in the home country money market. Higher (or lower) interest rates abroad are offset by changes in the exchange rate over time. Investors Residing in Attempt to Invest in i h i f e f Return in Home Currency I h Real Return Earned Japan Japan 5% 5% 0% 5% 3% 2% U.S. 5 8-3 5 3 2 Canada 5 13-8 5 3 2 U.S. Japan 8 5 3 8 6 2-11 -
U.S. 8 8 0 8 6 2 Canada 8 13-5 8 6 2 Canada Japan 13 5 8 13 11 2 U.S. 13 8 5 13 11 2 Canada 13 13 0 13 11 2 For example, the higher interest that a Japanese investor earns in the U.S. or Canada is offset by depreciation of the dollar or the Canadian dollar. According to the theory, measured in yen the Japanese investor on average makes the same rate of return (5% in the example above) whether the Japanese investor invests in the Japanese, American or Canadian money market. Derivation of the IFE According to the IFE, E(r f ), the expected effective return on a foreign money market investment, should equal r h, the effective return on a domestic investment. r f = (1 + i f ) (1 + e f ) - 1 Where: i f = interest rate in the foreign country e f = % change in the foreign currency's value r h = i h = interest rate in the home country Setting r f = r h : (1 + i f ) (1 + e f ) - 1 = i h Solving for e f : e f = (1 + i h ) (1 + i f ) 1 If i h > i f, e f > 0 (foreign currency appreciates) If i h < i f, e f < 0 (foreign currency depreciates) If i h = 8% & i f = 9%, e f = 1.08/1.09-1 = -.92% This will make the return on the foreign investment equal to the domestic return. When the interest rate in the foreign country is small, the IFE relationship can be simplified as: o e f i h - i f If the British rate on 6-month deposits were 2% above the U.S. interest rate, the should depreciate by approximately 2% over 6 months. Then U.S. investors would earn about the same return on British deposits as they would on U.S. deposits. - 12 -
Graphic Analysis of the IFE IFE holds along the diagonal line, where the percentage change in the exchange rate equals the interest rate differential. Log in to the course to view the graph that supports this section. Lower returns from investing in foreign deposits means that, measured in the home country currency, the rate of return from investing at home is greater than the rate of return from investing abroad, where the rate of return from investing abroad is the foreign interest rate adjusted for the change in the exchange rate. Higher returns from investing in foreign deposits means that, measured in the home country currency, the rate of return from investing at home is less than the rate of return from investing abroad, where the rate of return from investing abroad is the foreign interest rate adjusted for the change in the exchange rate. The point of the IFE theory is that if a firm periodically tries to capitalize on higher foreign interest rates, it will achieve a yield that is sometimes above and sometimes below the domestic yield. Attempting to capitalize on higher foreign interest rates is referred to as carry trade. This is different from covered interest arbitrage is that this is risky (speculation). The foreign currency is purchased in the spot market and then sold at a later date in the spot market at the future spot rate. On the average, the firm would achieve a yield similar to that by a corporation that makes domestic deposits only. Testing the IFE Theory (1 of 2) Linear regression is used to test the IFE theory. If the actual points of interest rates and exchange rate changes are plotted over time on a graph, we can see whether the points are evenly scattered on both sides of the IFE line. Empirical studies indicate that the IFE theory holds during some time frames. However, there is also evidence that it does not consistently hold. - 13 -
Testing the IFE Theory (2 of 2) A statistical test can be developed by applying regression analysis to the historical exchange rates and nominal interest rate differentials: o e f = a 0 + a 1 { (1+i h )/(1+i f ) - 1 } + μ The appropriate t-tests are then applied to a 0 and a 1, whose hypothesized values are 0 and 1 respectively. The hypothesized value for a 0 is that a 0 is equal to 0. The hypothesized value for a 1 is that a 1 is equal to 1. If you can reject either of the two null hypotheses, then you have evidence inconsistent with IFE theory. If you cannot reject either of the two null hypotheses, then you can conclude that you do not have evidence inconsistent with IFE theory. Why IFE Does Not Occur Since the IFE is based on PPP, it will not hold when PPP does not hold. For example, if there are factors other than inflation that affect exchange rates, the rates will not adjust in accordance with the inflation differential. Comparison of the IRP, PPP, and IFE Theories For only IRP, there is an arbitrage opportunity if the theory does not hold. For this reason, empirical evidence only strongly supports IRP. - 14 -
Note that for only interest rate parity, there is an arbitrage opportunity if the theory does not hold. For this reason, empirical evidence only strongly supports interest rate parity. Exercise The following questions are from the end of Chapter 8 in your course text. Question: Implications of IFE Assume U.S. interest rates are generally above foreign interest rates. W hat does this suggest about the future strength or weakness of the dollar based on the IFE? Should U.S. investors invest in foreign securities if they believe in the IFE? Should foreign investors invest in U.S. securities if they believe in the IFE? The IFE would suggest that the U.S. dollar will depreciate over time if U.S. interest rates are currently higher than foreign interest rates. Consequently, foreign investors who purchased U.S. securities would on average receive a similar yield as what they receive in their own country, and U.S. investors that purchased foreign securities would on average receive a yield similar to U.S. rates. Question: Comparing Parity Theories Compare and contrast interest rate parity (discussed in the previous chapter), purchasing power parity (PPP), and the international Fisher effect (IFE). Interest rate parity can be evaluated using data at any one point in time to determine the relationship between the interest rate differential of two countries and the forward premium (or discount). PPP - 15 -
suggests a relationship between the inflation differential of two countries and the percentage change in the spot exchange rate over time. IFE suggests a relationship between the interest rate differential of two countries and the percentage change in the spot exchange rate over time. IFE is based on nominal interest rate differentials, which are influenced by expected inflation. Thus, the IFE is closely related to PPP. Question: IFE Assume that the nominal interest rate in Mexico is 48 percent and the interest rate in the United States is 8 percent for one year securities that are free from default risk. W hat does the IFE suggest about the differential in expected inflation in these two countries? Using this information and the PPP theory, describe the expected nominal return to U.S. investors who invest in Mexico. If investors from the U.S. and Mexico required the same real (inflation adjusted) return, then any difference in nominal interest rates is due to differences in expected inflation. Thus, the inflation rate in Mexico is expected to be about 40 percent above the U.S. inflation rate. According to PPP, the Mexican peso should depreciate by the amount of the differential between U.S. and Mexican inflation rates. Using a 40 percent differential, the Mexican peso should depreciate by about 40 percent. Given a 48 percent nominal interest rate in Mexico and expected depreciation of the peso of 40 percent, U.S. investors will earn about 8 percent. (This answer used the inexact formula, since the concept is stressed here more than precision.) Question: IRP The one-year risk-free interest rate in Mexico is 10%. The one-year risk-free rate in the U.S. is 2%. Assume that interest rate parity exists. The spot rate of the Mexican peso is $.14. a. What is the forward rate premium? b. What is the one-year forward rate of the peso? c. Based on the international Fisher effect, what is the expected change in the spot rate over the next year? d. If the spot rate changes as expected according to the IFE, what will be the spot rate in one year? e. Compare your answers to (b) and (d) and explain the relationship. a. According to interest rate parity, the forward premium is (1 +.02) - 1 = -.07273-16 -
(1 +.10) b. The forward rate is $.14 (1 -.07273) = $.1298. c. According to the IFE, the expected change in the peso is: (1 +.02) (1 +.10) - 1 = -.07273 d. or -7.273% e. $.14 (1 -.07273) = $.1298 f. The answers are the same. W hen IRP holds, the forward rate premium and the expected percentage change in the spot rate are derived in the same manner. Thus, the forward premium serves as the forecasted percentage change in the spot rate according to IFE. Question: Real Interest Rates, Expected Inflation, IRP, and the Spot Rate The U.S. and the country of Rueland have the same real interest rate of 3%. The expected inflation over the next year is 6 percent in the U.S. versus 21% in Rueland. Interest rate parity exists. The one-year currency futures contract on Rueland's currency (called the ru) is priced at $.40 per ru. W hat is the spot rate of the ru? FR premium = (1.09)/(1.24) - 1 = -.12096 SR (1 + premium) = FR SR = FR/ (1 + premium) = $.40/(.87) = $.455 Log in to the course to access the answers for the remaining questions from the end of the chapter. Preparation for Exam 2 (Complete by the end of Day 7) It is strongly recommended that you review the study questions for Exam 1 (from W eek 4) and the study questions for Exam 2, found through the links below, to prepare for Exam 2. The questions on Exam 2 will come from material covered throughout the course, but there will be heavier emphasis on material covered in W eeks 4 and 5. Log in to the course to download the study questions. - 17 -
Summary With the completion of this lesson, you should understand the international Fisher Effect (IFE) theory, be able to explain the implications of IFE for exchange rate changes over time, derive IFE, and analyze and test IFE theory. You will need to be able to perform a statistical test (linear regression). You should also be able to interpret your regression results; this means that you should be able to explain the statistical significance of your results and state whether your results are consistent or inconsistent with the theory. Log in to the course to access the PowerPoint file for this lesson. End of Week 5-18 -