Lect09-International Financial Markets-VineyChptr15

47 resulting in a net increase in a ie sell a1 for 050

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Unformatted text preview: ward exchange rate f is an unbiased estimate of expected future spot rate E(s): f = E(s) • Again, market forces should ensure this equality holds true, otherwise arbitrage profits would be available . . . if f per $A > E(s) per $A ( say £0.50 > £0.47 ) arbitragers would enter into forward contract to sell $A @ f (here f = £0.50) at a future time, so they could then buy back $A at the expected lower E(s), (here £0.47), resulting in a net increase in $A. i.e. sell $A1 for £0.50, expect to get .50/.47 = $A1.06 back. The profit opportunity should be quickly competed away. 33 Purchasing Power Parity (PPP) • States that the expected change in an exchange rate is due to differences in expected inflation rates of the two countries. • Assume the exchange rate for £ per $A is s . . . i.e. $A1 = £ s According to the “law of one price” at any point in time, for a given commodity priced $A1 in Australia, then the price in the foreign country for that same commodity must be £ s. If the expected inflation rates in Australia a...
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This document was uploaded on 02/13/2014.

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