{"id":20886,"date":"2023-01-29T19:53:14","date_gmt":"2023-01-29T19:53:14","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=20886"},"modified":"2026-06-01T17:33:55","modified_gmt":"2026-06-01T17:33:55","slug":"the-relationship-among-international-parity-conditions","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/the-relationship-among-international-parity-conditions\/","title":{"rendered":"The Relationship among International Parity Conditions"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Which concept is least likely to be an underlying assumption of the International Fisher Effect?\",\r\n    \"text\": \"The International Fisher Effect is least likely based on which of the following? A. Real interest rate parity. B. Ex-ante purchasing power parity (PPP). C. Absolute purchasing power parity (PPP).\",\r\n    \"answerCount\": 3,\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"A. Real interest rate parity.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"B. Ex-ante purchasing power parity (PPP).\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"C. Absolute purchasing power parity (PPP).\"\r\n      }\r\n    ],\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is C. The International Fisher Effect is derived from the assumptions of real interest rate parity and ex-ante purchasing power parity. It links expected exchange rate movements to differences in nominal interest rates across countries. Absolute purchasing power parity is not a required assumption of the International Fisher Effect and is therefore least likely to be its basis.\"\r\n    },\r\n    \"author\": {\r\n      \"@type\": \"Organization\",\r\n      \"name\": \"AnalystPrep\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/jeWnVqcAZNs\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n\r\n<p>In the short run, most international parity conditions do not hold. However, over longer periods, they enjoy significant interaction among themselves courtesy of the interrelationship between interest rates, inflation rates, and exchange rates. Most notably:<\/p>\r\n<ol>\r\n\t<li>According to the ex-ante version of PPP, the expected change in spot exchange rates should equal the difference between the inflation rates of foreign and domestic countries.<\/li>\r\n\t<li>Provided that the ex-ante PPP and the Fisher effect hold, the difference in the foreign and domestic inflation rates must be equal to both the expected change in the exchange rate and the nominal interest rate differential. This is called the uncovered interest rate parity.<\/li>\r\n\t<li>When the Fisher effect holds, the difference between the foreign and domestic interest rates will be equal to the domestic-foreign expected inflation rate differential, which essentially is the international Fisher\u2019s effect.<\/li>\r\n\t<li>Assuming that both covered and uncovered interest parities hold, the forward exchange rate will be an unbiased predictor of the future spot exchange rate.<\/li>\r\n\t<li>In the uncovered interest parity, the expected percentage change of the spot exchange rate is expected to be reflected in the nominal interest rate spread.<\/li>\r\n\t<li>In the covered interest rate parity, arbitrage evens off the nominal interest rate spread and the percentage forward premium or discount.<\/li>\r\n<\/ol>\r\n<p>Looking at the points above, if all the international conditions are held constant most of the time, the spot exchange rate must be equal to the following:<\/p>\r\n<ol>\r\n\t<li>The difference (spread) in nominal interest rate (yield) between two countries.<\/li>\r\n\t<li>The percentage forward premium or discount.<\/li>\r\n\t<li>The expected national inflation rate differential.<\/li>\r\n<\/ol>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>The International Fisher effect is <em>least likely<\/em> based on which of the following?<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\" type=\"A\">\r\n\t<li>Real interest rate parity.<\/li>\r\n\t<li>Ex-ante PPP.<\/li>\r\n\t<li>Absolute PPP.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is C<\/strong>.<\/p>\r\n<p>The International Fisher\u2019s effect assumes that both real interest rate and ex-ante PPP hold.<\/p>\r\n<\/blockquote>\r\n<p>Reading 8: Currency Exchange Rates: Understanding Equilibrium Value<\/p>\r\n<p><em>LOS 8 (f) Describe the relations among the international parity conditions.<\/em><\/p>\r\n\r\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a><p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Access CFA Level II economics study notes, practice questions, mock exams, and video lessons to strengthen your understanding of international parity conditions and exchange rate relationships.<\/p><\/div>","protected":false},"excerpt":{"rendered":"<p>In the short run, most international parity conditions do not hold. However, over longer periods, they enjoy significant interaction among themselves courtesy of the interrelationship between interest rates, inflation rates, and exchange rates. Most notably: According to the ex-ante version&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,494],"tags":[216,502,511,510],"class_list":["post-20886","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-economics","tag-cfa-level-2","tag-economics","tag-reading-10","tag-relationship-among-international-parity-conditions","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>International Parity Conditions | AnalystPrep<\/title>\n<meta name=\"description\" content=\"Learn how international parity conditions relate exchange rates, inflation, interest rates, and the International Fisher Effect.\" \/>\n<meta name=\"robots\" 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