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International Parity Conditions and the Relationships with Exchange Rate - Application of PPP Hypothesis
1．INTRODUCTION
1.1 Background
In the international financial markets, international trade and exchange of goods and services across countries have raised the chances of transactions in different currencies, and therefore rises some of the fundamental questions such as: ‘What are the determinants of exchange rate?; Are changes in exchange rates predictable?’ etc are being asked everyday by those international portfolio investors, importers, exporters and government officials. However, different countries have their own economic situation. Sometimes, if only one country did some change on their government policy, it leads to the fluctuation in the exchange rate between countries. How can the exchange rate been predicted in a comparative stable economy environment? In the academia, it provided a corn theory. The three main parity conditions are: Purchasing Power Parity (PPP), International Fisher effect (IFE) and Interest Rate parity (IRP).

The purchasing power parity (PPP) condition concerns with the relative values or the exchange rate of two currencies and the prices in the two countries, while that the interest rate parity (IRP) condition identifies the relationship between the exchange rate, the forward rate and the interest rate in the two countries. And the relationship between changes in the exchange rate and the interest rate differential in the two countries was established by the international fisher effect (IFE) for exploiting the relationship between the interest rate differential and the inflation differential.

8.0 Reference
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