International finance exercises and applications

Purchasing power parity dictates competitive advantages within international finance. According to the theory of purchasing power parity, "the exchange rate between currencies of two countries should be equal to the ratio of the countries' price levels" (Eun & Resnick, 2012). Essentially, this sets the concept that price levels of currency have an impact on purchasing power and competitive advantage of countries within the international market environment. In this sense, "PPP requires that the price of the standard commodity basket be the same across countries when measured in a common currency" (Eun & Resnick, 2012). For countries to achieve parity, there needs to be an equality met within these two common factors.

Changes in the exchange rate ultimately have an impact on the competitiveness of countries within the larger international market. In this case, if a currency of a country depreciates more than what is justified through the purchasing power parity principle, that country will gain stronger competitiveness. On the other hand, if a country's currency increases in value, the competitive position within international finance will ultimately suffer and weaken (Moffatt, 2013). Thus, companies and businesses within countries that have an appreciating currency often find that their competitiveness within the word market is hurt. One of the most notable examples of this phenomenon is the case of China. The country purposely tries to keep the value of its currency to as little as possible because that ultimately provides it a much stronger competitive advantage in foreign markets (Hamlin, 2014). As its currency remains so low compared to the currency of other countries, it holds a strong competitive position, where its business interests can thrive. Today, China is set to actually surpass the United States in regards to its purchasing power parity.

Question 2

In order to determine when an American call option should be exercised within a rational market, the text provides the following equation:

(Eun & Resnick, 2012)