Treasury, Foreign Exchange and Financilization Essay

Treasury, Foreign Exchange and Financilization - Essay Example & O’Connell 2001) Therefore the PPP of country C with respect to the US dollar is as follows: Year PPP of country C with respect to US dollar 2003 1.02 2004 1.01 2005 1.01 2006 1.02 2007 1.01 The inflation rates for country D from 2003-2007 are as follows: (Mathis, Keat & O’Connell 2001) Therefore the PPP for country D with respect to the US dollar is: Year PPP of country D with respect to the US dollar 2003 0.99 2004 1.01 2005 0.98 2006 0.98 2007 0.99 Thus, these were the respective inflation rates of the countries A, B, C, D and their purchasing power parities calculated with respect to the US dollar. (b) The Purchasing Power Parity (PPP) Theory states that the exchange rate between the currencies of two countries is in equilibrium when their purchasing power is equivalent in both the countries. Let there be a fixed basket of goods and services and then let us determine the price of this common basket in both the countries. Then the exchange rate between the currencie s of the two countries should be equal to the ratio of the price levels of the two nations. PPP theory also states that when a country is subject to inflation i.e. there is a continuous increase in the level of domestic prices of the country, there should be depreciation in the country’s exchange rate in order to restore PPP. (The University of British Columbia 2011) We can see from the data in the case study, that while country A has experienced inflation from 2003-2007, the exchange rate of its currency with respect to the US dollar has depreciated during the same period (except for 2007). Thus, the PPP theory held true for country A. In country B also, as it was experiencing inflation during 2003-2007, the exchange rates of its currency with respect to the US dollar has devalued over the period (except for 2005). Thus the PPP theory held true in the case of country B also. As country C was going through a period of inflation from 2003-2007, the exchange rate between its cu rrency and the US dollar also underwent devaluation during the same period (except for 2005). Thus, for country C also, the PPP theory held good. In the case of country D, as it experienced inflation during 2003-2007, the exchange rate between its own currency and the US dollar remained the same in 2004 but devalued after that during the successive years. Thus the PPP theory also held good for country D. Therefore, the PPP theory held good for all the countries A, B, C, D. (c) The US dollar prime lending rate during 2002-2007 was as follows: Year US dollar lending prime rate 2002 4.67 2003 4.12 2004 4.34 2005 6.19 2006 7.96 2007 8.05 (Board of Governors of the Federal Reserve 2011) The