interest rate parity

When you shop around youll get the inside quote the

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Unformatted text preview: f CIRP and UIRP are the same. Therefore, iff UIRP holds, F0,T S0 1 i0,T * 1 i0,T E S 0,T 1 i0,T ; F0,T E S 0,T * S0 1 i0,T The current forward rate is an optimal predictor of the future spot exchange rate! 94 20 Does F Predicts S? (cnt.) The question: “does UIRP hold ” is the same as “does F predict S ” If UIRP holds, it is either • risk-neutrality • zero systematic risk 95 Does F Predicts S? (cnt.) It is fundamentally an empirical question • Not very well; F follows S • Never predicts turning points • Not easy to do much better This includes professional forecasting services 96 Does F Predicts S? (cnt.) It is fundamentally an empirical question. • Not very well; F follows S • Never predicts turning points • Not easy to do much better This includes professional forecasting services • Random walk forecasts have the same characteristics! Ger-ft-t.xls F and S are tied together by CIRP • Siamese twins Interest rate fluctuations are small 97 21 Real Rate Parity If PPP holds and the capital markets are open and efficient, then Real interest rates are equalized across countries, up to a risk premium 98 Short Term Market and Real Rates Internationally 21.00% Market Rates Interest Rates 16.00% Real Rates 11.00% 6.00% 1.00% A U S A S T R B E L C A N D E N F I N F R A G E R I T A J P N N E T H S P A S W E S W I U K U S G R H K I R E K O R M A L M E X N O R S I N G T A I W * -4.00% 99 Takeaways The $-Equivalent return makes foreign currency returns comparable to $ returns UIRP says that on average the returns from foreign deposits will be same as a $ deposit Doesn’t work so well, lots of risk CIRP says that the covered returns from foreign deposits will be same as a $ deposit Works very well; if not then arbitrage (synthetic forward) If UIRP holds, then Ft,T = E(St+T) 100 22 The End 101 23...
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This note was uploaded on 01/16/2010 for the course FBE 436 at USC.

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