J m keynes a tract on monetary reform 1923 r j hawkins

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Unformatted text preview: onetary Reform (1923) R. J. Hawkins: Covered Interest Parity Econ 136: Financial Economics 2/ 22 Covered Interest Parity: Examples By arbitrage: Sf /d (1 + rf ) = (1 + rd ) Ff /d Two basic questions: 1 Solve for one variable given the other three. 2 Identify arbitrage trade opportunities. R. J. Hawkins: Covered Interest Parity Econ 136: Financial Economics 13/ 22 Arbitrage Example 1 Recall our basic equality: Sf /d (1 + rf ) = (1 + rd ) Ff /d . What to do if (1 + rd ) > 1 Construct position (portfolio) today: 1 2 3 4 2 Sf /d (1 + rf ) = Sf /d (1 + rf ) Fd/f Ff /d Borrow from foreign bank. (short a deposit) Covert loan to domestic currency at the spot rate. Lend to domestic bank. (long a deposit) Enter into domestic-to-foreign forward fx position. Close out position (portfolio) in the future: 1 2 3 Take proceeds from domestic deposit. Covert to foreign currency at prearranged rate. Repay loan from foreign bank. R. J. Hawkins: Covered Interest Parity Econ 136: Financial Economics 18/ 22 Arbitrage Example 2 Recall our basic equality: Sf /d (1 + rf ) = (1 + rd ) Ff /d . What to do if (1 + rf ) > 1 Construct positi...
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