ch12 (2) - Covered Interest Parity (CIP) condition No...

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Covered Interest Parity (CIP) condition No arbitrage condition For the market to be in equilibrium the riskless returns must be equal when expressed in a common currency: Figure 13.8: Arbitrage and Covered Interest Parity Under CIP, returns to holding dollar deposits accruing interest going along the path AB must equal the returns from investing in euros going along the path ACDB with risk removed by use of a forward contract. Hence, at B, the riskless payoff must be the same on both paths, and (1 + i $ ) = F $ / / E $ /€ (1 + i ). Arbitrage profit? Considers the German deutschmark (GER) relative to the British pound (UK), 1970-1994. Determine whether foreign exchange traders could earn a profit through establishing forward and spot contracts The profit from this type of arrangement is: Figure 13.9: Financial Liberalization and Covered Interest Parity: Arbitrage between United Kingdom and Germany The chart shows the difference in monthly pound returns on deposits in British pounds and German marks using
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This note was uploaded on 03/02/2012 for the course EC 340 taught by Professor Ballie during the Spring '10 term at Michigan State University.

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ch12 (2) - Covered Interest Parity (CIP) condition No...

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