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Basic Question 6 of 27
The law of one price means that:
II. A unit of home currency must have the same purchasing power worldwide.
III. Foreign exchange rates will react to differences between domestic and foreign rates of inflation.
IV. Only small deviations from equilibrium can exist in the long run.
I. A particular TV set that sells for 750 CAD in Vancouver should cost 500 USD in Seattle when the exchange rate between Canada and the U.S. is 1.50 CAD/USD.
II. A unit of home currency must have the same purchasing power worldwide.
III. Foreign exchange rates will react to differences between domestic and foreign rates of inflation.
IV. Only small deviations from equilibrium can exist in the long run.
User Contributed Comments 4
| User | Comment |
|---|---|
| Walkiria | no deviations at all! |
| Masterkang | No - big deviations CAN exist in the short run. |
| rhardin | From the notes: "The law of one price means that arbitragers prevent all but small deviations from equilibrium." So... It seems to me that IV would be correct too, at least in the short run. |
| itsmclovin | In the short run, so IV "long run" is not correct. |
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Learning Outcome Statements
explain international parity relations (covered and uncovered interest rate parity, forward rate parity, purchasing power parity, and the international Fisher effect);
describe relations among the international parity conditions;
evaluate the use of the current spot rate, the forward rate, purchasing power parity, and uncovered interest parity to forecast future spot exchange rates;
explain approaches to assessing the long-run fair value of an exchange rate;
CFA® 2025 Level II Curriculum, Volume 1, Module 8.