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In order to avoid such a risk (or to minimize the risk) or to increase the profits, the investor is likely to use covered interest arbitrage. When the investor purchases a financial instrument in a foreign currency, he will sell, at the same time, a forward contract in an estimated amount, which would change the foreign currency back into the reference currency at the time the operations are completed (over the respective timeframe). The investor will either see the initial investment protected against currency risks or the profits from the investment will actually increase.
5. The link between the inflation and exchange rates comes from the definition of the purchasing power parity theory, according to which "the exchange rate between one currency and another is in equilibrium...
What this means is that the inflation rate will adjust the exchange rate between two countries so as to avoid potential situations where speculation could be done with products by buying them in one country and selling them in another, taking into consideration only the exchange rate.
Bibliography
1. Moffatt, Mike. A Beginner's Guide to Purchasing Power Parity Theory. On the Internet at http://economics.about.com/cs/money/a/purchasingpower.htm. Last retrieved on February 2, 2010
Moffatt, Mike. A Beginner's Guide to Purchasing Power Parity Theory. On the Internet at http://economics.about.com/cs/money/a/purchasingpower.htm. Last retrieved on February 2, 2010
Bibliography
1. Moffatt, Mike. A Beginner's Guide to Purchasing Power Parity Theory. On the Internet at http://economics.about.com/cs/money/a/purchasingpower.htm. Last retrieved on February 2, 2010
Moffatt, Mike. A Beginner's Guide to Purchasing Power Parity Theory. On the Internet at http://economics.about.com/cs/money/a/purchasingpower.htm. Last retrieved on February 2, 2010
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