To Find: Forward Rate Premium or Discount use 2). (Present Time Arbitrage Condition) To predict inflation rates given interest rates, use 8). For Exchange rate expectations use 7) 1) National Production (GNP) = National Income C + I + G + X = C + S + T + M 2) Covered Interest Rate Parity : (F/S) = (1 + i $ )/(1 + i F ); If F>S then it is trading at a premium 3) Hedging currency risk: a) Buy forward contract for amt. you need in foreign currency b) Amount needed in foreign/(1+i f ) = amt. invested in today which yields amt. needed c) Take that, divided by spot rate. d) Borrow that amt. domestically. At time t, you will sell forward that amt. + interest 4) Triangular arbitrage: Divide dollar exchange rate for currency 1 by dollar ex. rate for currency 2. 5) Relative PPP : Exchange rate will adjust to changes in prices levels of two countries S 1 /S0 = (1+Π d ) t / (1+ Π f ) t Low inflation means appreciates that currency 6) Real Exchange Rate : nominal adjusted for inflation. Foreign Goods/Domestic Goods
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