Universal Circuit

The real exchange rate is the nominal exchange rate adjusted for changes in the relative purchasing power of each currency (Shapiro, 1999). This concept can be linked to the theory of Purchasing Power Parity (PPP), first introduced by Gustav Cassel in 1918 and defined as:

e (home)/e (foreign) = p (home)/p (foreign) (formula 1)

e = spot rate

3. Would you approve the controller's request to buy punt forward? What considerations factor in your decision? Why should or why shouldn't you view this decision in isolation (that is, how precedent-setting is it?)? Your answer should incorporate the organizational context. What kinds of managerial behaviour are you likely to stimulate by permitting or not permitting foreign controllers to hedge exchange-rate risks?

3. Would you approve the controller's request to buy punt forward? What considerations factor in your decision? Why should or why shouldn't you view this decision in isolation (that is, how precedent-setting is it?)? Your answer should incorporate the organizational context. What kinds of managerial behaviour are you likely to stimulate by permitting or not permitting foreign controllers to hedge exchange-rate risks?

p = Inflation

In absolute terms, it states that currencies should have the same purchasing power all over the world. Transportation costs, tariffs, quotas, restrictions and product differentiation are ignored though.

The relative version of PPP states that the exchange rate between home and foreign currency will adjust to reflect changes in price levels of the two countries. So, if inflation in the US is 5% and 3% in the UK, then sterling must rise by 2% in order to equalise the dollar price of goods in the two countries.

Vice versa, when calculating real appreciation or depreciation, it is necessary to adjust for inflation rates. Therefore, real appreciation or depreciation of a currency is that adjusted for inflation and is calculated using the following formula: