CIMA Official Learning System P3 — Performance Strategy （13）Foreign Exchange: Relationships and Risks

L EARNING O UTCOMES
After completing this chapter you should be able to:
? explain and distinguish between purchasing power parity, interest-rate parity and the
international Fisher effect theories;
? calculate the impact of differential infl ation and interest rates on forecasting
exchange rates;
? identify and explain the different types of foreign exchange risks;
? identify and evaluate appropriate strategies of minimising political risks.
1 3.1 Introduction
The main purpose of this chapter is to introduce the mechanics of the foreign exchange
market and to discuss the relationship between infl ation, interest rate and exchange rates
according to the purchasing power parity (PPP) theory, interest-rate parity (IRP) and the
international Fisher effect (IFE). We then examine the different types of exposures to for-
eign exchange risk; transaction exposure, translation exposure and economic exposure. The
chapter concludes with a brief summary.