seems like most foreign exchange equations generally use the DC/FC convention. anyone know why they change it up for this one: Relative PPP states that the exchange rate between two countries will adjust to offset differences in inflation rates. It is the rate of inflation that is critical here. Relative PPP requires only that the exchange rate be proportional to the ratio of the two price indexes. The value of higher-inflation currencies will be depressed relative to the value of lower-inflation currencies, all other things equal. The relative PPP equation for multiple periods is: E(St) / S0 = [1 + E(iFC)]t / [1 + E(iDC)]t Where S0 is in FC/DC
With the exception of maybe one or two, every formula in that section uses FC/DC. The prior reading uses DC/FC, as does the Portfolio Management sections. Personally I hate the FX stuff. It’s tedious memorization that doesn’t mean anything to me. Oh well.
Just remember to use the same convention on both sides of the equation. If the exchange rate is in FC/DC , then the inflation rate in the numerator should be of FC and the inflation in the denominator should be in DC. If the Exchange rate is in DC/FC, then the inflation rate in the numerator should be in DC. Simple.
It’s also reversed in the second part of the question on the asset market model for FX rates.
Also do a reality check - Look at the numbers and check that they make sense. For PPP, remember that if inflation is higher in country A than in country B, then country A’s currency will depreciate. So look at the answer you get and make sure that it has depreciated!
As Christmas said,If a country is experiencing an inflation then their currency will tend to depreciate so you can always do a sense-check to determine whether the value that you are getting makes sense after the fact.If not then your guess is as right as mine. Be sure that the wrong answer that you calculate will by part of the answers. I can bet my last cent on that.