Question

Which of the following statements is/are FALSE ?

• A. The arbitrage pricing theory says that the prices which producers in different countries set for a particular product will be the same if the prices are expressed in the same currency using the current exchange rate
• B. The interest rate parity theory says that the interest rates on similar assets in two countries will always be the same
• C. The Purchasing Power Parity theory says that the total prices of any basket of products which apply in two different countries will be the same, if the prices are expressed in the same currency using the current exchange rate
• D. The real exchange rate between two countries is the rate at which a particular basket of products produced in one country can be traded with a similar basket produced in another country

Answer 1

The Correct Option is A, B

To determine which statements are FALSE, let's analyze each concept they describe:

1. Arbitrage Pricing Theory (APT): This theory is primarily related to asset pricing and risk-return equilibrium in financial markets, not about product prices across different countries. Therefore, the statement claiming APT relates to product prices in different countries is FALSE.
2. Interest Rate Parity (IRP): This relates to the relationship between interest rates and the exchange rates of two countries. It doesn't claim that interest rates on similar assets in two countries will always be the same. Thus, the statement is FALSE as it misunderstands IRP.
3. Purchasing Power Parity (PPP): This theory states that in the absence of transaction costs and other barriers, the prices of identical products in different countries should equalize when expressed in the same currency. The statement about PPP is TRUE.
4. Real Exchange Rate: This measures how much of a product one can trade with another product across countries, in real terms considering inflation. The description of the real exchange rate as the exchange rate for trading baskets of products is correct, hence TRUE.

Based on the above analysis, the FALSE statements are the first and second ones: The arbitrage pricing theory and the interest rate parity theory aspects mentioned are incorrect.