International ParityRelationships & ForecastingExchange RatesChapter Four
Chapter Objective:*This chapter examines several key internationalparity relationships, such as interest rate parityand purchasing power parity.* It help us to get some insight in (1) how theexchange rates are determined and (2)how toforecast the exchange ratesKeyconcept:arbitrage
2 Chapter Objective: ❖ This chapter examines several key international parity relationships, such as interest rate parity and purchasing power parity. ❖ It help us to get some insight in (1) how the exchange rates are determined and (2)how to forecast the exchange rates. ❖ Key concept: arbitrage
ChapterOutlineInterest Rate ParityPurchasingPower ParityTheFisherEffectsForecasting Exchange Rates
3 Chapter Outline ❖Interest Rate Parity ❖Purchasing Power Parity ❖The Fisher Effects ❖Forecasting Exchange Rates
InterestRateParityLawofOnePriceInterestRateParityDefinedCovered interest arbitrageCovered Interest ParityUncovered Interest ParityReasons forDeviations from InterestRateParity
4 Interest Rate Parity Law of One Price Interest Rate Parity Defined Covered interest arbitrage Covered Interest Parity Uncovered Interest Parity Reasons for Deviations from Interest Rate Parity
Law of oneprice (一价定律)Law of one price means the two things that are equalto each other must be selling for the same priceSuppose Tom have $1 to invest for one year.1invest in the U.S. at ius. Maturity value = $1 (1 + ius)(suppose ius is the interest rate in the U.S. )2.Dtrade one dollars for pound at the spot rate; @invest in UK at iuk and hedge the exchange raterisk by selling the future value of the Britishinvestmentforward
5 Law of one price（一价定律） ➢ Law of one price means the two things that are equal to each other must be selling for the same price. ➢ Suppose Tom have $1 to invest for one year. 1. invest in the U.S. at iUS. Maturity value = $1 (1 + ius) (suppose ius is the interest rate in the U.S. ) 2. ①trade one dollars for pound at the spot rate; ② invest in UK at iUK and ③hedge the exchange rate risk by selling the future value of the British investment forward