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Unformatted text preview: on (portfolio) today:
4 2 Ff /d (1 + rd )
= Ff /d (1 + rd ) Sd/f
Sf /d Borrow from domestic bank. (short a deposit)
Covert loan to foreign currency at the spot rate.
Lend to foreign bank. (long a deposit)
Enter into foreign-to-domestic forward fx position. Close out position (portfolio) in the future:
3 Take proceeds from foreign deposit.
Covert to domestic currency at prearranged rate.
Repay loan from domesic bank.
R. J. Hawkins: Covered Interest Parity Econ 136: Financial Economics 19/ 22 The Diﬀerential: The f /d version
Recall our basic equality: Sf /d (1 + rf ) = (1 + rd ) Ff /d .
Collecting currency rates and interest rates:
(1 + rd )
(1 + rf )
= 1 − rf + higher-order terms
(1 + rf )
We can write:
≈ 1 + rd − rf
Sf /d − Ff /d
≈ rd − rf
R. J. Hawkins: Covered Interest Parity Econ 136: Financial Economics 20/ 22 The Synthetic Call
50 OPTION PRICE (arbitrary) IN THE MONEY Synthetic Portfolio OUT OF THE MONEY 40 1 BREAKEVEN
10 Long the underlying. 3 20 Long European put. 2 30 Short (borrow) K...
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- Fall '08