The implications of the deviations of the purchasing power Essay

The implications of the deviations of the purchasing power - Essay Example The deviation from PPP will also result in the variation of operating margins significantly. This will in turn affect the competitiveness of the multi-national companies. The main reason for the failure of Law of One Price is the presence of transaction cost. When the deviation of the exchange rate from PPP raises, arbitrage forces will later on become more strong. For a company who deals with differentiated goods, by grouping under one category, the PPP will deviate and this will result in increase in arbitrage forces.Question 2: You are hired by a South African firm with all local costs that has recently entered the export market. The firm prices their contracts in US$, as this is necessary to gain market share. They now realize that with 25% of sales as exports, they face a reasonably sized exchange rate exposure and are not sure whether they should hedge it or not. Knowing that you have training in international financial management, they ask you for advice. Provide a summary of your response on the types of foreign exchange risk this company faces and whether the firm should hedge the exposure. The Company Faces Transaction Risk and Economic Risk:â€Å"Transaction risk, which is basically cash ï ¬â€šow risk, deals with the effect of exchange rate moves on transactional account exposure related to receivables (export contracts), payables (import contracts), or repatriation of dividends. An exchange rate change in the currency of denomination of any such contract will result in a direct transaction exchange rate risk to the ï ¬ rm†.