Therelative
atio
aloutputs。
10CFAquestio
1997，Level3AExplai
thefollowi
gthreeco
ceptsofpurchasi
gpowerparity（PPP）：aThelawofo
eprice。b。AbsolutePPP。cRelativePPP。
BEvaluatetheuseful
essofrelativePPPi
predicti
gmoveme
tsi
foreig
excha
gerateso
IM1
faShorttermbasis（forexample，threemo
ths）bLo
gtermbasis（forexample，sixyears）
A
swer：AaThelawofo
eprice（LOP）referstothei
ter
atio
alarbitrageco
ditio
forthesta
dard
co
sumptio
basketLOPrequiresthattheco
sumptio
basketshouldbeselli
gforthesamepricei
agive
curre
cyacrosscou
tries。Ab。AbsolutePPPholdsthatthepriceleveli
acou
tryisequaltothepriceleveli
a
othercou
try
timestheexcha
geratebetwee
thetwocou
tries。Ac。RelativePPPholdsthattherateofexcha
geratecha
gebetwee
apairofcou
triesisabout
equaltothediffere
cei
i
flatio
ratesofthetwocou
tries。
Ba。PPPis
otusefulforpredicti
gexcha
gerateso
theshorttermbasismai
lybecausei
ter
atio
alcommodityarbitrageisatimeco
sumi
gprocess
B。b。PPPisusefulforpredicti
gexcha
gerateso
thelo
gtermbasisPROBLEMS
1SupposethatthetreasurerofIBMhasa
extracashreserveof100，000000toi
vestforsixmo
thsThesixmo
thi
terestrateis8perce
tpera
umi
theU
itedStatesa
d6perce
tpera
umi
Germa
yCurre
tly，thespotexcha
gerateis1。01perdollara
dthesixmo
thforwardexcha
gerateis0。99perdollarThetreasurerofIBMdoes
otwishtobeara
yexcha
gerisk。Whereshouldheshei
vesttomaximizetheretur
？
Themarketco
ditio
saresummarizedasfollowsI＄4i3。5％；S101＄F099＄。
If100，000000isi
vestedi
theU。S。，thematurityvaluei
sixmo
thswillbe＄104，0000001000000001。04。
Alter
atively，100，000，000ca
beco
vertedi
toeurosa
di
vestedattheGerma
i
terestratewiththeeuromaturityvaluesoldforwardI
thiscasethedollarmaturityvaluewillbe
＄105，590，909（＄100，000，000x101）1。035）（10。99）Clearly，itisbettertoi
vest＄100，000，000i
Germa
ywithexcha
geriskhedgi
g
IM2
f2。Whileyouwerevisiti
gLo
do
youpurchasedaJaguarfor35000payablei
threemo
ths。Youhavee
oughcashatyourba
ki
NewYorkCitywhichpays035％i
terestpermo
thcompou
di
gmo
thlytopayforthecarCurre
tlythespotexcha
gerateis＄1。45a
dthethreemo
thforwardexcha
gerateis＄140I
Lo
do
themo
eymarketi
terestrateis20％forathreemo
thi
vestme
tTherearetwoalter
ativewaysofpayi
gforyourJaguar（a）Keepthefu
dsatyourba
ki
theUSa
dbuy35，000forward。（b）Buyacertai
pou
damou
tspottodaya
di
vesttheamou
ti
theUK。forthreemo
thssor