Wk14_15Nov_Ch18_IRParity

Wk14_15Nov_Ch18_IRParity - Wk14: Tuesday, Nov. 14, 2011...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
Tuesday: Ch. 18 – Interest Rate Parity Thursday: Ch. 19 – Purchasing Power Parity Overall theme: Details of the forces that influence exchange rates - in the short run (interest rate parity) - in the long run (purchasing power parity) Wk14: Tuesday, Nov. 14, 2011
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Today Covered Interest Rate Parity Uncovered Interest Rate Parity Empirical Evidence on both Parity Conditions
Background image of page 2
Covered Interest Parity Due to pressure from arbitrage: The return on a domestic deposit will equal the overall return on a foreign deposit which has been hedged with a forward contract.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Covered Interest Parity U.S. CFO has $20 million in cash which she will need in three months. Online data: Return on 3-month domestic deposit: i US = .03 Return on 3-month foreign deposit: i UK = . 04 Your recommendation?
Background image of page 4
More Data Return on 3-month domestic deposit: i US = .03 Return on 3-month foreign deposit: i UK = . 04 Spot exchange rate: e $/£ = $2.00/£ 3-month forward exchange rate: f $/£ = $1.96/£ Return on U.S. deposit: $20M (1 + i US ) = $20M (1+.03) Return on U.K. deposit: Convert $’s to £’s $20M/e $/£ = $20/($2/£) = £10M
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Compute Returns Return on U.S. deposit: $1 (1 + i US ) $20M (1+.03) = $20.600 Return on U.K. deposit: Convert $’s to £’s $1 (1/e $/£ ) $20M/($2/£) = £10M Compute earnings $1 (1/e $/£ ) (1 + i UK ) £10M (1+.04) = £10.4M Sell pounds forward $1 (1/e $/£ ) (1 + i UK ) f $/£ £10.4M x $1.96/£ =
Background image of page 6
More Generally Return on Return on. U.S. Deposit U.K. Deposit (1 + i US ) vs. (1 + i UK ) (f $/£ /e $/£ ) Forward Premium F = (f- e)/e (1.96 $/£ -2.00 $/£ )/2.00 $/£ = -.02 AN Approximation i US vs. i UK + F .03 .04 - .02
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
U.S. Deposit U.K. Deposit (1 + i US ) = (1 + i UK ) (f $/£ /e $/£ ) Suppose < Then invest in U.K. Impact: e $/£ rises, f $/£ falls, i UK falls, i US rises Suppose > Then invest in U.S. Impact:
Background image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 01/28/2012 for the course ECN 306 taught by Professor Croucher during the Fall '08 term at ASU.

Page1 / 32

Wk14_15Nov_Ch18_IRParity - Wk14: Tuesday, Nov. 14, 2011...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online