Changes in Real Exchange Rates
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.
- 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
- CAPM & the SML
- 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