What Determines Exchange Rates? From Last time • Can a normal person buy call options in DM? Yes, although the minimum amount may be quite large. • If the spot exchange rate goes up or down, what happens to the forward exchange rate? If the interest rate parity condition holds, if the spot rate goes up, the forward rate will also have to go up, everything else the same. • Uncovered interest parity says that a currency is expected to appreciate by the percentage point difference between the foreign interest rate and the domestic interest rate. Suppose the U.S. interest rate is 6% and the interest rate on a comparable Japanese security is 8%, then the dollar is expected to rise 2% against the yen. This makes the return from holding the two bonds equal. Covered interest parity applies the same idea to the forward and spot rates. For the previous example, covered inte r est parity would say that the dollar's value against the yen in the forward market is 2% higher than the value in the spot market. Prices and Exchange Rates
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This note was uploaded on 11/22/2011 for the course FIN FIN1100 taught by Professor Bradrifkin during the Fall '09 term at Broward College.