Purchasing Power Parity

Purchasing power parity:

-When currency rates are set by international markets changes will be based on the actual purchasing power of the currency.

Ex. U.S dollar to Euro rate is $1.5 to 1 euro than each $1.50 would buy 1 euro, however if an item in the U.S cost $1.5 and then cost more or less than one euro the parity is lost 

-Markets will adjust quickly in floating rates or pressure for change will occur in fixed rate

Why do we exchange currencies?

-Invest in other countries

-Buy stocks and bonds 

-Build factories or stores in other markets

-Speculate on currency values

-Hold currency in bank account for future exports imports and future business loans

-Control excessive imbalances