1. International Financial Management: INBU 4200 Fall Semester 2004 Lecture 4: Part 2 International Parity Relationships: The Purchasing Power Parity; A Case Study of the Impact of Hyper-inflation on a Currency’s Exchange Rate (Chapter 5)

2. Background on the Turkey and the Lira During the decade of the 1990s, Turkey experienced hyper inflation. The CPI peaked at 106.3% in 1994. One of the consequences of this hyper inflation was a severe depreciation of the country’s currency, the Turkish Lira. From an average of 9 Lira per US Dollar in the late 1960s, the currency came to trade at approximately 1,650,000 per US Dollar in late 2002 and early 2003. –Now trading around 1,500,000

3. Turkey’s Rates of Inflation: CPI 1991 66.0%1998 84.6% 1992 70.1%1999 64.9% 1993 66.1%2000 54.9% 1994 106.3%2001 55.4% 1995 88.1%2002 45.0% 1996 80.3% 1997 85.7%

4. Lira: 1991 - 2004

5. Lira Today Lira is the world’s smallest valued unit of currency. One lira worth approximately 0.000000743971 US dollars! –A chocolate bar can often cost more than a million Lira!

6. 20,000,000 Lira banknote

7. Changing Currency The Government has announced the introduction of a new currency to replace the old Lira. The new currency, the New Turkish Lira will be issued on January 1, 2005. – It will be equivalent to 1,000,000 old Turkish Lira, or –One New Lira will be worth one million old ones

8. General Conclusion Relatively high rates of inflation result in weakness (depreciation) of a country’s currency on foreign exchange markets. Theoretical explanation for this relationship, is the Purchasing Power Parity model. –Exchange rates will change by an amount which is equal to, but opposite in sign to, inflation differentials. –High inflation country currencies will weaken –Low inflation country currencies will strengthen