ch06 interest rate parity

ch06 interest rate parity - Slide 6 2011 Dr. William F....

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1 Some Important Terms Exchange rate Direct quote Indirect quote Spot rate Forward exchange rate
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2 Covered Interest Arbitrage CAD1,000,000 to invest k domestic = 2%, 91-day (CAD) rate k foreign = 1%, 91-day (USD) rate Slide 1
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3 Covered Interest Arbitrage Spot Rate S 0 = CAD1.333…/USD direct quote (Cdn. View) Slide 2
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4 Covered Interest Arbitrage Spot Rate 1/S 0 = USD0.75/CAD indirect quote (Cdn. View) Slide 3
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5 Covered Interest Arbitrage 91-day Forward Rate F = CAD1.35/USD direct quote (Cdn. View) Slide 4
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6 Covered Interest Arbitrage Invest in Canada CAD1,000,000 x (1 + k domestic ) = CAD1,020,000 Slide 5
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7 Covered Interest Arbitrage Invest in US Return in CAD (CAD1,000,000/S 0 ) x (1 + k f ) x F
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Unformatted text preview: Slide 6 2011 Dr. William F. Rentz & Associates, All Rights Reserved 8 Covered Interest Arbitrage (USD750,000) x 1.01 x CAD1.35/USD = CAD1,022,625 Slide 7 2011 Dr. William F. Rentz & Associates, All Rights Reserved 9 Covered Interest Arbitrage Borrow CAD1,000,000 and invest in the US. Gain = CAD1,022,625 - CAD1,020,000 = CAD2,625 Slide 8 2011 Dr. William F. Rentz & Associates, All Rights Reserved 10 CONCLUSION Covered Interest Arbitrage will continue until the spot, forward, domestic interest rate, and foreign interest rate adjust so that no further gain is possible. Slide 9 2011 Dr. William F. Rentz & Associates, All Rights Reserved 11 Interest Rate Parity (1 + k domestic ) = (F/S ) (1 + k f ) 2011 Dr. William F. Rentz & Associates, All Rights Reserved 12 Example: k domestic = 2.1% k foreign = 0.9% S = CAD1.3334/USD F = CAD1.349258/USD 2011 Dr. William F. Rentz & Associates, All Rights Reserved 13 Invest in Canada Total Return = CAD1,021,000 Invest in US Total Return = CAD1,020,999.94...
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This note was uploaded on 03/12/2012 for the course TELFER ADM2350 taught by Professor Rentz during the Winter '12 term at University of Ottawa.

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ch06 interest rate parity - Slide 6 2011 Dr. William F....

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