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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.
- Fall '13