Parity Pricing by helpwithassignment.com

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This work focuses on explaining the concepts of Parity Pricing in International markets. It is an effort made by www.helpwithassignment.com to help you excel in this subject. You can contact us at http://www.helpwithassignment.com if you need further help with the topic or any assignment related to the same.

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Parity Pricing by helpwithassignment.com

  1. 1. What is Parity Pricing in International Markets? www.HelpWithAssignment.com
  2. 2. Table of Content <ul><li>Purchasing Power Parity </li></ul><ul><li>Interest Rate Parity </li></ul><ul><li>Interest Rates & Exchange Rates </li></ul>
  3. 3. Parity Pricing in International Markets <ul><li>Purchasing Power Parity (PPP): </li></ul><ul><li>The theory that states that the exchange rate between one currency and anther is in equilibrium when their domestic purchasing powers at that rate of exchange are equivalent </li></ul><ul><li>Concept: </li></ul><ul><li>If the exchange rate is AU$1.00 = US$0.60, the exchange rate is in equilibrium when AU$1.00 will buy the same goods in Australia as US$0.60 in the US </li></ul>
  4. 4. Parity Pricing in International Markets <ul><li>Concept of PPP (continued): </li></ul><ul><li>The price of tradable goods, when expressed in a common currency, will tend to equalise across countries as a result of exchange rate changes </li></ul><ul><li>Consumers will shift their demand, assuming no international barriers, and purchase goods from the country offering the lowest price for the same goods </li></ul><ul><li>Where consumers shift their demand abroad, on the basis of price, increased demand will force foreign price rises and therefore re-establish price equilibrium (PPP) </li></ul>
  5. 5. Parity Pricing in International Markets <ul><li>Impact of Inflation on PPP: </li></ul><ul><li>Inflation is defined as the persistent increases in the general level of prices that devalue the worth of money. </li></ul><ul><li>Assume that inflation in Australia is 3.0% and </li></ul><ul><li>inflation in the US is 1.0%. General price levels are therefore rising faster in Australia compared to the US </li></ul><ul><li>If consumers switch demand to US goods the exchange rate will adjust (US$ up / AUD down) to re-establish price equilibrium </li></ul>
  6. 6. Parity Pricing in International Markets <ul><li>Inflation Rate Differences </li></ul><ul><li>Assume inflation rates are higher in the US than the UK </li></ul><ul><li>US consumers buy GB£ to buy UK goods (& sell US$) </li></ul><ul><li>Supply (SS) GB£ shifts left </li></ul><ul><li>Demand (DD) GB£ shifts right </li></ul><ul><li>As a result, GB£ appreciates: GB£ buys more US$ (US$ depreciates) </li></ul>Quantity Supplied of UK Currency Price of UK Currency (US$) P1 Q Currency Equilibrium SS1 DD SS DD1 P
  7. 7. Parity Pricing in International Markets <ul><li>Example PPP: </li></ul><ul><li>Therefore: AU$1.99 = ₤107.00 = HK$1150.00 (21/12/08) </li></ul>8gb iPod nano AU$ GB₤ HK$ http://store.apple.com/au $199.00 http://store.apple.com/uk ₤ 107.00 http://store.apple.com/hk $1150.00
  8. 8. Parity Pricing in International Markets <ul><li>AU$199.00 = ₤107.00 = HK$1150.00 </li></ul><ul><li>Need to measure in a single currency (AU$) </li></ul><ul><li>AU$199.00 = ₤107.00 = HK$1150.00 </li></ul><ul><li>AU$199.00 AU$199.00 AU$199.00 </li></ul><ul><li>AU$1.00 = ₤0.537 = HK$5.779 </li></ul><ul><li>Compare www.oanda.com (21/12/2008) </li></ul><ul><li>AU$1.00 = ₤0.457= HK$5.32 </li></ul><ul><li>So which country has the cheapest iPod? </li></ul>
  9. 9. Parity Pricing in International Markets <ul><li>So which country has the cheapest iPod? </li></ul><ul><li>AU$1.00 = ₤0.457= HK$5.32 (indirect) </li></ul><ul><li>AU$2.188 = ₤1.00 and AU$0.188 = HK$1.00 (direct) </li></ul><ul><li>The respective costs of an iPod are: </li></ul><ul><li>UK equiv. = ₤107.00 x AU$2.188 = AU$234.12 </li></ul><ul><li>HK equiv. = HK$1150.00 x AU$0.188 = AU$216.17 </li></ul><ul><li>@ AU$199 Australia has the cheapest iPod . Why? </li></ul>
  10. 10. Parity Pricing in International Markets <ul><li>Does PPP work? </li></ul><ul><li>Exchange rate may not fully adjust because of </li></ul><ul><li>Interest rate differentials </li></ul><ul><li>Growth rate differentials </li></ul><ul><li>Inflation rate differentials </li></ul><ul><li>Income differentials </li></ul><ul><li>Government policy differentials </li></ul><ul><li>Combination of the above </li></ul>
  11. 11. Parity Pricing in International Markets <ul><li>Does PPP work? </li></ul><ul><li>In the short run there are variations for the reasons stated, however, over the long run deviations in the exchange rate are reduced and PPP is considered accurate. </li></ul>
  12. 12. <ul><li>Interest Rate Parity: </li></ul><ul><li>To extinguish arbitrage opportunities, the quoted difference between the forward fx rate and the spot rate (F – S ) is offset by the interest rate differentials </li></ul><ul><li>Assume that the interest rate in Australia is 6.0% and </li></ul><ul><li>interest rate in the UK is 3.0% </li></ul><ul><li>If UK investors switch their investments to Australian dollars, the exchange rate will adjust (AU$ up / GB₤ down) to re-establish interest rate equilibrium </li></ul>Parity Pricing in International Markets
  13. 13. Parity Pricing in International Markets <ul><li>Interest Rate Differences </li></ul><ul><li>Assume interest rates are higher in the US than the UK </li></ul><ul><li>UK investors invest in US$ and sell of GB£ </li></ul><ul><li>Supply (SS) GB£ shifts right </li></ul><ul><li>Demand (DD) GB£ shifts left </li></ul><ul><li>As a result , GB£ depreciates: GB£ buys fewer US$ (US$ appreciates) </li></ul>Quantity Supplied of UK Currency Price of UK Currency (US$) P Q Currency Equilibrium SS DD1 SS1 DD P1
  14. 14. Parity Pricing in International Markets <ul><li>Example Interest Rate Parity: </li></ul>Interest Rates (12 mth) US GB AU www.bloomberg.com 0.00 5.75 7.5 Exchange Rate US GB AU www.oanda.com 1.00 0.666 1.458 Forward Rates (12 mth) US GB AU www.cme.com 1.00 0.664 1.469
  15. 15. Parity Pricing in International Markets <ul><li>Interest Rate Parity example (continued) </li></ul>US$ GB₤ AU$ US$1,000,000 equiv 1,000,000.00 666,000.00 1,458,000.00 Add interest 0.00 38,295.00 109,350.00 Total 1,000,000 704,295.00 1,567,350.00 Futures Rate (÷ 1.0) (÷ 0.664 ) (÷ 1.469 ) Convert back to US$ 1,000,000 US$1,060,685 US$1,060,143 Effective Rate of Interest 0.00 0.0607 0.0601
  16. 16. Thank You <ul><li>Hope this presentation helps you in understanding the concepts of Parity Pricing. </li></ul><ul><li>If you have further doubts, please feel free to reach us at support@helpwithassignment.com </li></ul>

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