chapter  4
6 Pages

Strategic Structural Hedging

Purchasing Power Parity (PPP) Theory The purchasing power parity (PPP) theory is that in the longer term the exchange rate between the currencies of two countries will alter in relation to their respective rates of inflation. The PPP rate is the exchange rate between two currencies at which there is competitive parity in costs of production in each of the two economies. For example, if a basket of goods representing a typical spread of manufactured products costs $1,500,000 in the US and an identical basket of goods costs £1,000,000 in the UK, the sterling/dollar PPP rate is £1 = $1.50. At that exchange rate UK manufacturers would be broadly competitive with their US counterparts.