Register / Login

Changes in Real Exchange Rates

Premium

Nominal Exchange Rates represent how many units of one currency can be exchanged for one unit of another currency.
Nominal exchange rates are the rates quoted in the global markets for foreign currency exchange.
Real Exchange Rates represent the amount of purchasing power in one currency can be exchanged for one unit of another currency.

Example: 10 Euros buys one "global burger joint chain meal deal" in Paris; converting 10 Euros to US dollars and going into the same chain in downtown Cincinnati buys 1.5 of the same meal deals.
Determining Change to Real Exchange Rate
Real and Nominal Exchange Rates under PPP

SR X/Y = SN X/Y / (PX / PY)

SR X/Y = Real X/Y exchange rate measuring purchasing power
SN X/Y = The nominal X /Y exchange rate; i.e. the forex market quote
PX = Price of a standard basked of goods in country X
PY = Price of the same basket of goods in country Y
Percent Change of the Nominal Exchange Rate under PPP

% SN PPP X/Y = ((1 + I X )/ (1 + I Y )) - 1

I = Inflation rate over measurement period
The amount of change in the real exchange rate between the currencies of two countries can be calculated by comparing an observed change in nominal exchange rates of the two currencies with the currency change predicted by Purchasing Power Parity.

% SR X/Y = ((1 + %ΔS N X/Y ) / (1 + % SN PPP X/Y )) - 1

The real exchange rate between two currencies will change whenever the nominal exchange rate changes by an amount that is not explained by inflation.

Unlock Premium Content

Upgrade your account to access the full article, downloads, and exercises.

You'll get access to:

Access complete tutorials and examples
Download source code and resources
Follow along with practical exercises
Get in-depth explanations

Previous Lesson

Domestic CAPM and Extended CAPM

International CAPM (ICAPM) - Beyond Extended CAPM

Portfolio Management

29 lessons

CFA Level 2: Portfolio Management – Introduction

Mean-Variance Analysis Assumptions

Expected Return and Variance for a Two Asset Portfolio

The Minimum Variance Frontier & Efficient Frontier

Diversification Benefits

The Capital Allocation Line – Introducing the Risk-free Asset

The Capital Market Line

Adding an Asset to a Portfolio – Improving the Minimum Variance Frontier

The Market Model for a Security’s Returns

Adjusted and Unadjusted Beta

Multifactor Models

Arbitrage Portfolio Theory (APT) – A Multifactor Macroeconomic Model

Risk Factors and Tracking Portfolios

Markowitz, MPT, and Market Efficiency

International Capital Market Integration

Domestic CAPM and Extended CAPM

Changes in Real Exchange Rates

International CAPM (ICAPM) - Beyond Extended CAPM

Measuring Currency Exposure

Company Stock Value Responses to Changes in Real Exchange Rates

ICAPM vs. Domestic CAPM

The J-Curve – Impact of Exchange Rate Changes on National Economies

Moving Exchange Rates and Equity Markets

Impacts of Market Segmentation on ICAPM

Justifying Active Portfolio Management

The Treynor-Black Model

Portfolio Management Process

The Investor Policy Statement

Topics

Financial Markets

Portfolio Management

Related Groups

Finance Concepts