ch04_2 - 4-1Chapter 4Chapter 4The International Parity...

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Unformatted text preview: 4-1Chapter 4Chapter 4The International Parity ConditionsThe International Parity ConditionsLearning objectivesThe Law of One Price Exchange rate equilibriumInternational parity conditions These relate exchange rates to cross-currency interest rate and inflation differentialsInterest rate parityis the most important relation The real exchange rate Measuring inflation-adjusted currency valuesButler / Multinational FinanceChapter 4 The International Parity Conditions4-2Though this be madness, yet there is method in it. William ShakespeareButler / Multinational FinanceChapter 4 The International Parity Conditions4-3PricesPrices appear as Upper Case SymbolsPtd=price of an asset at time t in currency d Std/f= spot exchange rate at time t in currency dFtd/f=forward exchange rate between currencies d and falsoE=expectation operator (e.g. E[St/$])The law of one price and interest rate parityLess reliable parity conditions The real exchange rateAppendix: Continuous compoundingNotation and definition Parity in the market for goldCross exchange rate equilibriumInterest rate parity and covered interest arbitrageButler / Multinational FinanceChapter 4 The International Parity Conditions4-4Returns (rates of change)Changes in a price appear as lower case symbolsptd=inflation in currency d in period tstd/f=change in the spot rate during period ttd=real interest rate in currency d in period trtd=an assets return in currency d during period tThe law of one price and interest rate parityLess reliable parity conditions The real exchange rateAppendix: Continuous compoundingNotation and definition Parity in the market for goldCross exchange rate equilibriumInterest rate parity and covered interest arbitrageButler / Multinational FinanceChapter 4 The International Parity Conditions4-5The law of one priceEquivalent assets sell for the same price(also called purchasing power parity, or PPP)Seldom holds for nontraded assetsCant compare assets that vary in qualityMay not hold precisely when there are market frictionsThe law of one price and interest rate parityLess reliable parity conditions The real exchange rateAppendix: Continuous compoundingNotation and definition Parity in the market for goldCross exchange rate equilibriumInterest rate parity and covered interest arbitrageButler / Multinational FinanceChapter 4 The International Parity Conditions4-6PricerelativePfSf/$P$to the $USA ($)3.411.003.411.00Britain ()1.99 0.4984.001.17Euro-zone ()3.061.362.250.66Hong Kong (HK$)12.07.821.530.45Japan ()2801222.300.67S. Korea (Won)29009233.140.92Switzerland (SFr)6.301.215.211.53Purchasing power (dis)parity: The Big Mac IndexThe law of one price and interest rate parityLess reliable parity conditions The real exchange rateAppendix: Continuous compoundingNotation and definition Parity in the market for goldCross exchange rate equilibriumInterest rate parity and covered interest arbitrageButler / Multinational FinanceChapter 4 The International Parity Conditions4-7...
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ch04_2 - 4-1Chapter 4Chapter 4The International Parity...

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