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    Interest Rate Parity

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    sukantabiswas
    The document discusses interest rate parity, which relates nominal interest rate differentials between countries to the forward premium or discount on their currencies. If interest rates are higher in country A than country B, country B's currency should trade at a forward premium. This prevents arbitrage by equalizing expected returns across countries. The document outlines the implications: if domestic rates are lower than foreign rates, the foreign currency must trade at a discount to prevent arbitrage, and vice versa if domestic rates are higher. Interest rate parity implies no arbitrage opportunities between domestic and foreign investment.

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    Interest Rate Parity

    Uploaded by

    sukantabiswas
    58 views8 pages
    The document discusses interest rate parity, which relates nominal interest rate differentials between countries to the forward premium or discount on their currencies. If interest rates are higher in country A than country B, country B's currency should trade at a forward premium. This prevents arbitrage by equalizing expected returns across countries. The document outlines the implications: if domestic rates are lower than foreign rates, the foreign currency must trade at a discount to prevent arbitrage, and vice versa if domestic rates are higher. Interest rate parity implies no arbitrage opportunities between domestic and foreign investment.

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    The document discusses interest rate parity, which relates nominal interest rate differentials between countries to the forward premium or discount on their currencies. If interest rates are higher in country A than country B, country B's currency should trade at a forward premium. This prevents arbitrage by equalizing expected returns across countries. The document outlines the implications: if domestic rates are lower than foreign rates, the foreign currency must trade at a discount to prevent arbitrage, and vice versa if domestic rates are higher. Interest rate parity implies no arbitrage opportunities between domestic and foreign investment.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    58 views8 pages

    Interest Rate Parity

    Uploaded by

    sukantabiswas
    The document discusses interest rate parity, which relates nominal interest rate differentials between countries to the forward premium or discount on their currencies. If interest rates are higher in country A than country B, country B's currency should trade at a forward premium. This prevents arbitrage by equalizing expected returns across countries. The document outlines the implications: if domestic rates are lower than foreign rates, the foreign currency must trade at a discount to prevent arbitrage, and vice versa if domestic rates are higher. Interest rate parity implies no arbitrage opportunities between domestic and foreign investment.

    Copyright:

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    Download as PPT, PDF, TXT or read online from Scribd
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    Interest Rate Parity

    Presented by Debankur Majumdar

    Outline
    Meaning of Interest Rate Parity Implications of Interest Rate Parity What if Interest Rate Parity holds? What if Interest Rate Parity does not hold?
    The concept of covered interest arbitrage

    Other considerations when assessing

    Interest Rate Parity

    Meaning of Interest Rate Parity


    Uses nominal interest rates to analyze the relationship

    between spot rate and a corresponding forward rate Relates interest rate differentials between home country and foreign country to the forward premium/discount on the foreign currency The size of the forward premium or discount on a currency should be equal to the interest rate differential between the countries of concern If nominal interest rates are higher in country A than country B, the forward rate for country Bs currency should be at a premium sufficient to prevent arbitrage

    According to IRP:

    F/S = (1+rd)/(1+rf) OR (1+rd) F = ----------- S (1+rf)

    Thus, F is less than S, if rf > rd and F is more than S, if rf < rd Forward Premium/Discount of a foreign currency: (rd - rf) ---------- (1+rf)
    If IRP holds, arbitrage is not possible; it does not matter whether you

    invest in domestic country or foreign country, your rate of return will be the same as if you invested in home country when measured in domestic currency

    Implications of IRP
    If domestic interest rates are less than foreign

    interest rates, foreign currency must trade at a forward discount to offset any benefit of higher interest rates in foreign country to prevent arbitrage If foreign currency does not trade at a forward discount or if the forward discount is not large enough to offset the interest rate advantage of foreign country, arbitrage opportunity exists for domestic investors. Domestic investors can benefit by investing in the foreign market

    If domestic interest rates are more than foreign

    interest rates, foreign currency must trade at a forward premium to offset any benefit of higher interest rates in domestic country to prevent arbitrage If foreign currency does not trade at a forward premium or if the forward premium is not large enough to offset the interest rate advantage of domestic country, arbitrage opportunity exists for foreign investors. Foreign investors can benefit by investing in the domestic market

    Thank You

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