International Parity Relationships and Forecasting Foreign Exchange Rates

Save this PDF as:
 WORD  PNG  TXT  JPG

Size: px
Start display at page:

Download "International Parity Relationships and Forecasting Foreign Exchange Rates"

Transcription

1 International Parity Relationships and Forecasting Foreign Exchange Rates 6 Chapter Six Chapter Objective: This chapter examines several key international parity relationships, such as interest rate parity and purchasing power parity. 6-0 Chapter Outline Interest Rate Parity Purchasing Covered Interest Power Arbitrage Parity IRP and Exchange Rate Determination Fisher The PPP Fisher Effects Deviations Effects and the Real Exchange Rate Reasons for Deviations from IRP Evidence on Purchasing Power Parity International Forecasting Exchange Fisher Effects Rates Purchasing The Fisher Effects Power Parity Efficient Market Approach The Forecasting Fundamental Fisher Effects Exchange Approach Rates Forecasting Technical Approach Exchange Rates Performance of the Forecasters 6-1 1

2 Interest Rate Parity Interest Rate Parity Defined Covered Interest Arbitrage Interest Rate Parity & Exchange Rate Determination Reasons for Deviations from Interest Rate Parity 6-2 Interest Rate Parity Defined IRP is an no arbitrage condition. If IRP did not hold, then it would be possible for a trader to make unlimited amounts of money exploiting the arbitrage opportunity. Since we don t typically observe persistent arbitrage conditions, we can safely assume that IRP holds. almost all of the time! 6-3 2

3 Variable Definitions i H : Interest Rate in the home country i F : Interest Rate in the foreign country S = Current spot rate for the foreign currency (in direct quote) F = 1 year forward rate for the foreign currency (in direct quote) FP H = one year forward premium from the home country s viewpoint = (F-S) / S FP F = one year forward premium from the foreign country s viewpoint = (S- F)/For(1/FP F FP H 1) i CH : Covered rate of interest, from the home country s viewpoint i CF : Covered rate of interest, from the foreign country s viewpoint (1 + i F $/ = S $/ $ ) (1 + i ) 6-4 Interest Rate Parity Carefully Defined Consider two alternative one-year investments for $1 1. You could invest in the US at i H. Future value of this investment in $ will be: $1 (1 + i H ) = (1 + i H ) 2. Or you could convert $1 into the foreign currency at the going spot rate (S) and invest 1/S in the foreign country at i F whose future value will be: [1/S (1 + i H )]. In order to eliminate any exchange rate risk, you will have to sell this amount at forward rate (F) to get you money back in $: Fx[1/S (1 + i H )] Since these investments have the same risk, they must have the same future value (otherwise an arbitrage would exist) F (1 + i F $/ = S $/ $ ) (1 + i F ) = (1 + i (1 + i ) S H ) 6-5 3

4 Interest Rate Parity Defined Formally, 1 +i H F = 1 + i F S 1 + i H Or -1 = F S 1 + i F S IRP is sometimes approximated as i H F S i F S = FP 6-6 Interest Rate Parity Carefully Defined Depending upon how you quote the exchange rates, direct (S, F) or indirect (S I, F I ), we have: 1 + i F F I = 1 + i S H I or 1 + i H F = 1 + i F S so be a bit careful about that

5 Interest Rate Parity Carefully Defined No matter how you quote the exchange rate (direct or indirect) to find a forward rate, increase the dollars by the dollar rate and the foreign currency by the foreign currency rate: F I = S I 1 + i F 1 + i H or F = S 1 + i H 1 + i F 6-8 be careful it s easy to get this wrong. Covered Rate of Interest Home Country s viewpoint (i CH ) = CH (1 + i F ) x (1 + FP H ) - 1 Foreign Country s viewpoint i (i CF ) = 6-9 (1 + i H ) x (1 + FP F $/ ) -= 1S $/ (1 + i $ ) (1 + i ) 5

6 IRP & Covered Interest Arbitrage (CIA) CIA is possible when: i CH > i H i CF > i F When CIA is possible, i H, i F, and FP will have to adjust to eliminate arbitrage. IRP holds when CIA is not possible: 6-10 i CH = i H i CF = i F F $/ = S $/ (1 + i $ ) (1 + i ) IRP and Covered Interest Arbitrage If IRP failed to hold, an arbitrage would exist. It is easiest to see this in the form of an example. Consider the following set of foreign and domestic interest rates and spot and forward exchange rates. Spot exchange rate for GBP S = $ day forward rate for GBP F = $ US interest rate i H = 5.00% British interest rate i F = 8.00%

7 IRP and Covered Interest Arbitrage If IRP failed to hold, an arbitrage would exist. It is easiest to see this in the form of an example. Consider the following set of foreign and domestic interest rates and spot and forward exchange rates. Spot exchange rate for GBP S = $ day forward rate for GBP F = $ US interest rate i H = 5.00% British interest rate i F = 8.00% 6-12 IRP and Covered Interest Arbitrage

8 IRP and Covered Interest Arbitrage If IRP failed to hold, an arbitrage would exist. It is easiest to see this in the form of an example. Consider the following set of foreign and domestic interest rates and spot and forward exchange rates. Spot exchange rate for BP S = $ day forward rate for BP F = $ US interest rate i H = 8.00% British interest rate i F = 4.00% 6-14 IRP and Covered Interest Arbitrage If IRP failed to hold, an arbitrage would exist. It is easiest to see this in the form of an example. Consider the following set of foreign and domestic interest rates and spot and forward exchange rates. Spot exchange rate for BP S = $ day forward rate for BP F = $2.090 US interest rate i H = 8.00% British interest rate i F = 4.00%

9 Reasons for Deviations from IRP Transactions Costs The interest rate available to an arbitrageur for borrowing, i b may exceed the rate he can lend at, i l. There may be bid-ask spreads to overcome, F b /S a < F/S Capital Controls Governments sometimes restrict import and export of money through taxes or outright bans Reasons for Deviations from IRP

10 Purchasing Power Parity The concept of Absolute and Relative Purchasing Power Parity (PPP) PPP and Exchange Rate Determination PPP Deviations and the Real Exchange Rate Consequences of PPP Violations Evidence on PPP 6-18 Absolute Purchasing Power Parity A dollar should buy the same quantities of goods and services in all countries According to absolute PPP, in the long run, currencies should move towards the rate which equalizes the prices of an identical basket of goods and services in each country The exchange rate (direct quote) between two (S) currencies should equal the ratio of the countries price levels in the home (P H ) and foreign (P F ) country: S = (P H / (P F ) Examples

11 Absolute Purchasing Power Parity and Exchange Rate Determination P H S = P F For example, if an ounce of gold costs $1200 in the U.S. and 800 in Europe, then the price of one euro in terms of dollars should be: $1200 S = = $1.50/ 800 What happens if S = 1.25 or S = 1.75? 6-20 Does PPP Hold? More Examples

12 Evidence on Absolute PPP Absolute PPP probably doesn t hold precisely in the real world ldfor a variety of reasons: Tradable and non-tradable factors of production Haircuts cost 10 times as much in the developed world as in the developing world. Film, on the other hand, is a highly standardized commodity that is actively traded across borders. Shipping costs, as well as tariffs and quotas can lead to deviations from PPP. Relative PPP-determined exchange rates can provide a more valuable benchmark PPP: Evidence

13 Does PPP Hold? The Case of Big Mac 6-24 Relative Purchasing Power Parity Even if the dollar does not buy the same basket of goods in other countries, the purchasing power of the dollar in these countries could remain stable over time. We can show that according to Relative PPP: If two countries have different inflation rates, then the exchange rates between the two countries will adjust to maintain equality of relative purchasing power for the citizens of both countries. The real exchange rate will remain constant

14 Variable Definition S= Current spot rate (price of foreign currency) in direct quote S 1 = Actual spot rate, 1 year from now F = 1-year forward rate FP = the forward premium = [(F-S) / S] = [(F/S) - 1] H = Inflation rate in the home country F = Inflation rate in the foreign country E(S 1 ) = Expected spot rate, 1 year from now, based on PPP E(e) = [E(S 1)/S] 1 = The expected percentage change, or rate of change, in the spot rate, based on PPP e = (S 1 /S) 1 = The actual percentage change, or rate of change, in the spot rate S r = real spot rate 6-26 Absolute Purchasing Power Parity and Exchange Rate Determination P H S = P F For example, if an ounce of gold costs $1200 in the U.S. and 800 in Europe, then the price of one euro in terms of dollars should be: $1200 S = = $1.50/ 800 What happens if S = 1.25 or S = 1.75?

15 Purchasing Power Parity and Exchange Rate Determination Suppose the spot exchange rate (S) is $1.50 = 1.00 If the inflation rate in the U.S. ( H ) is expected to be 5% in the next year and 3% in the euro zone( F ), Then the expected exchange rate in one year E(S) should be such that $1.50 (1.05) = 1.00 (1.03) E(S 05) 1 ) = $1.50 (1.05) $1.575 = = $ (1.03) 1.03 E(e) = [E(S 1 )/S 1] = $ =.019 = 1.94% $ Purchasing Power Parity and Exchange Rate Determination Because of the inflation differential, the euro is expected to appreciate by 1.94% in the spot market by the end of the year: $1.50 (1.05) E(S 1 ) 1.00 (1.03) = = H = S $ F 1.00 Relative PPP states that the rate of change in the exchange rate is equal to differences in the rates of inflation roughly 2% Also remember that E(S 1 ) = F So that: expected rate of change in the exchange rate = forward premium, or E(e) = FP

16 Relative Purchasing Power Parity According to Relative PPP: Approximately: E(e) E(S 1 ) 1 + = H S 1 + F 1 + E(e) = H F E(S 1 ) = = H - F S [1 + E(e)] 6-30 Real Exchange Rate Real exchange rate is the spot rate adjusted for inflation, let us call it S r. It is supposed to tell us if a foreign currency has appreciated or depreciated, after adjusting for inflation. S r = S 1 Under PPP, real exchange rates should remain constant Suppose the US the current spot rate for is 1.50 and US inflation rate is 5% while the inflation rate is 3% in the euro zone. If the spot rate next year turns out to be 1.52, the real exchange rate is: 1.52*(1.03/1.05) = $1.491 We can say that although the spot rate for appreciated in nominal terms from $1.50 to $1.54, it actually depreciated in real terms from $1.50 to $1.491 This would weaken the US s competitive position against Europe

17 PPP & Competitiveness We can also use PPP to determine the competitiveness of the home country s currency q = = = E(S 1 )/S 1 q = 1: Competitiveness of home country is unchanged q < 1: Competitiveness of home country has improved q > 1: Competitiveness of home country has deteriorated 6-32 PPP Conditions Summarized PPP is Violated PPP Holds Foreign currency has Foreign currency has appreciated (USD has depreciated) in real terms depreciated (USD has appreciated) in real terms No Change US exports more competitive US exports less competitive S 1 =E(S 1 ) S 1 > E(S 1 ) S 1 < E(S 1 ) e= E(e) e> E(e) e< E(e) S = S r S > S r S< S r q = 1 q < 1 q >

18 PPP: EXAMPLE 1 Inflation rate in the US is 5%; H = 0.05 Inflation rate in the Europe is 3%; F = 0.03 Current spot rate for is $1.50; S = 1.50 To maintain relative PPP, the expected percentage change in the spot exchange rate for, E(e) = (1.05) / (1.03) - 1 = % To maintain relative PPP, the expected spot exchange rate for, at the end of the year, E(S 1 ) = $1.50 ( )= $ per If, 1 year latter the actual spot rate, S 1 for turns out to be $1.54 $1.52 Compared to E(S 1 ) of $1.5291, S 1 is higher lower Actual % change in S: e = (S 1 /S) % % The real rate for, S r = S 1 *[1.03/1.05] $ $ q is equal to: [1+E(e)] / [1 + e ] = E(S 1 )/S The real rate (S r ) has: increased decreased In real terms, has: appreciated depreciated US s competitiveness has: improved deteriorated 6-34 PPP: EXAMPLE 2 Inflation rate in the US is 5%; H = 0.05 Inflation rate in the Switzerland is 2%; F = 0.08 Current spot rate for SF is $0.90; S = 0.90 To maintain relative PPP, the eexpectedexpected percentage change in the spot exchange rate for SF, E(e) = (1.05) / (1.08) - 1 = % To maintain relative PPP, the expected spot exchange rate for SF, at the end of the year, E(S 1 ) = $0.90 ( )= $0.875 per SF If, 1 year latter the actual spot rate, S 1 for SF turns out to be $0.86 $0.88 Compared to E(S 1 ) of $0.875, S 1 is lower higher Actual % change in S: e = (S 1 /S) % % The real rate for SF, S r =S 1 *[1.08/1.05] $ $ q is equal to: [1+E(e)] / [1 + e ] = E(S)/S The real rate (S r ) has: decreased increased In real terms, SF has: depreciated appreciated US s competitiveness has: deteriorated improved

19 Purchasing Power Parity and Interest Rate Parity Notice that the PPP & IRP equations are equal because E(S) = F or E(e) = FP: PPP IRP E(S) 1 + = H 1 + i H F = = S 1 + F 1 + i F S E(e) = 1 + H 1 + i -1 H = -1 = FP 1 + F 1 + i F 6-36 PPP: Evidence

20 Expected Rate of Change in Exchange Rate as Inflation Differential We could also reformulate our equations as inflation or interest rate differentials: F($/ ) S($/ ) = 1 + $ 1 + F($/ ) S($/ ) = 1 + $ 1 = 1 + $ 1 + S($/ ) E(e) = F($/ ) S($/ ) = $ S($/ ) 1 + $ Fisher Effect The nominal interest rate is composed of a real interest rate and an expected inflation rate. Nominal interest rate: i; Real rate: ρ; Expected inflation: (1 + i) = (1 + ρ) (1 + ) i = ρ + + ρ Approximately: i = ρ + If real rates are equal across countries, or: ρ H = ρ F Then: (1 + i H ) / (1 + i F ) = (1 + H ) / (1 + F ) Approximately : i H -i F = H - F

21 International Fisher Effect (IFE) The concept of IEF IFE Conditions Deviations of from IFE: uncovered rates of interest: from the home and foreign country s view point 6-40 International Fisher Effect (IFE) In an integrated global money and capital markets: (1) Domestic fisher effect holds in each country. (2) All investors have the same real rate of return worldwide. (3) Therefore all nominal interest rate differences must be due to inflation differences

22 International Fisher Effect (IFE) The exchange rate of a country with a higher (lower) interest rate than its trading partner should depreciate (appreciate) by the amount of the interest rate difference to maintain equality of real rates of return IFE: Terminology i H = Nominal interest rate for the home country i F = Nominal interest rate for the foreign country S = Current spot rate (direct quote) for the foreign currency (in home currency units) S 1 = Next year s spot rate (direct quote) for the foreign currency

23 Uncovered Rate: Home County s View point The uncovered rate from the home county s point of view (i UH ) is the rate earned by the holders of dollars by: 1. Converting DOLLARS into FOREIGN CURRENCY today at the current spot exchange rate (S), and 2. Investing the FOREIGN CURRENCY at the FOREIGN INTEREST RATE (i F ), and 3. Converting FOREIGN CURRENCY back into DOLLARS at maturity using the future spot exchange rate (S 1 ) This return is affected by two factors: whether the foreign currency appreciates or depreciates against the dollar = % change in direct quote (DQ) = (S 1 -S)/ S The rate of interest you earn in the foreign country = i F You calculate it as: i UH = (1 + % change in DQ)*(1 + i F ) 1 Profit making Strategy: If i UH > i H then borrow in dollars and invest in foreign currency If i UH < i H then borrow in foreign currency and invest in dollars If i UH = i H then you cannot make any profit 6-44 Uncovered Rate: Foreign County s View point The uncovered rate from the foreign county s point of view (i UF ) is the rate earned by the holders of foreign currency by: 1. Converting FOREIGN CURRENCY into DOLLARS today at the current spot exchange rate (S), and 2. Investing the DOLLARS at the US INTEREST RATE (i H ), and 3. Converting DOLLARS back into FOREIGN CURRENCY at maturity using the future spot exchange rate (S 1 ) This return is affected by two factors: whether the US Dollars appreciates or depreciates against the foreign currency = % change in indirect quote (IQ) = (S 0 -S 1 ) / S 1 The rate of interest you earn in the home country (US) = i H You calculate it as: i UF = (1 + % change in IQ)*(1 + i H ) 1 Profit making strategy : If i UF > i F then borrow in foreign currency and invest in dollars If i UF < i F then borrow in dollars and invest in foreign currency If i UF = i F then you cannot make any profit

24 IFE Conditions According to IFE one should not be able to make money by consistently borrowing in one country and investing in another These conditions are met when: i UH = i H or i UF = i F According to IFE the above conditions will hold only when the expected percentage change in the spot rate, E(e): E(e)= (1 + i H ) / (1 + i F ) 1 Approximately: E(e)= i H -i F According to IFE, the expected spot rate 1 year from now, E(S 1 ), should be: E(S 1 ) = S [1 + E(e)] 6-46 Uncovered Rate and IFE: Summarized If i UH > i H or i UF < i F then investors will profit if they: borrow in the home country (US) convert the $ loan amount into foreign currency invest in the foreign capital market at the end of the borrowing/investment period convert the foreign currency back into domestic currency ($) and pay off the domestic (US) loan If this continues then: S, E(S1), i H, i F, until i UH = i H or i UF = i H, or IFE holds If i UF > i F or i UH < i H then investors will profit if they: borrow in the foreign country convert the loan amount from foreign currency into domestic currency ($) invest in the domestic (US) capital market at the end of the borrowing/investment period convert the domestic currency ($) back into foreign currency and pay off the foreign loan If this continues then: S, E(S1), i H, i F, until i UH = i H or i UF = i H, or IFE holds

25 IFE : Example 1 Interest rate in US, i H = 7 % & Euro zone interest rate, i F = 9 % Current spot rate for, S = $1.40 According to IFE, the percentage change in exchange rate, based on direct quote, for should be: E(e) = (1.07) / (1.09) - 1 = % According to IFE, the expected spot rate for at the end of the year should be: E(S 1 ) = $1.40 ( ) = $ 1.37 / What happens if you believe (predict) that S 1 will be $1.39? You could make money by borrowing in $ and investing in Can you show how? What happens if you believe (predict) that S 1 will be $1.35? You could make money by borrowing in and investing in $ Can you show how? 6-48 IFE : Example 2 Interest rate in US, i H = 7% & Interest rate in Switzerland, i F = 3% Current spot rate for SF (S)= $0.85 According to IFE, the percentage change in exchange rate, based on direct quote, SF should be: E(e) = (1.06) / (1.03) - 1 = % According to IFE, the expected spot rate for SF at the end of the year should be: E(S 1 ) = $0.85 ( ) = $0.883 / SF What happens if you believe (predict) that S 1 will be $0.90? You could make money by borrowing in $ and investing in FF Can you show how? What happens if you believe (predict) that S 1 will be $0.87? You could make money by borrowing in SF and investing in $ Can you show how?

26 Approximate Equilibrium Exchange Rate Relationships IFE E(e) ( ) FEP (i H i F ) IRP PPP F S S E( H F ) 6-50 Exact Equilibrium Exchange Rate Relationships IFE E ( S 1 ) S FEP 1 + i H 1 + i F IRP PPP F S E(1 + H ) E(1 + F )

27 Variable Definitions S= Current spot rate (price of foreign currency) in direct quote S 1 = Actual spot rate, 1 year from now F = 1-year forward rate FP H = the forward premium = [(F-S) / S] = [(F/S) - 1] from the home country s view point FP F = the forward premium = [(S-F) / F] = [(S/F) - 1] from the foreign country s view point H = Inflation rate in the home country F = Inflation rate in the foreign country ρ = Real rate of interest E(S 1 ) = Expected spot rate, 1 year from now, based on PPP E(e) = [E(S 1 )/S] 1 = The expected percentage change, or rate of change, in the spot rate, based on PPP e = (S 1 /S) 1 = The actual percentage change, or rate of change, in the spot rate S r = real spot rate i H = Nominal interest rate for the home country i F = Nominal interest rate for the foreign country Formula: Purchasing Power Parity (PPP) Exact relationship: E(e) =(1 + π H )/(1+π π F ) - 1 Approximate relationship: E(e) = π H - π F S 1 = S 0 * [ 1 + E(e) ] S R = S 1 *(1 + π F ) / (1 + π H ) Fisher Equation: (1 + i) = (1 + ρ) )(1 + ) ) i = ρ + + ρ Approximately: i = ρ + 27

28 Formula: International Fisher Effect (IFE) Fisher Equation: (1 + i) = (1 + ρ) (1 + ) i = ρ + + ρ Approximately: i = ρ + i uh : Uncovered rate of return, home country s viewpoint i uf : Uncovered rate of return, foreign country s viewpoint i uh = (1 + i f ) (1 + % change in DQ ) 1 i uf = (1 + i h ) (1 + % change in IQ ) 1 % change in DQ (direct quote)= (S 1 - S 0 )/S 0 % change in IQ (indirect quote) = [1 /(1+ % change in DQ] - 1 The IFE relationship holds when: E(e)= (1 + i H ) / (1 + i F ) 1 Approximately: E(e)= i H i F S 1 =S 0 * [1 + E(e)] Formula: Interest Rate Parity (IRP) Calculating the covered rate of returns (home & foreign country s view point) i ch = Covered rate of return, home country s view point i cf = Covered rate of return, foreign country s view point i ch = (1 + i f ) (1 + FP h ) 1 i cf = (1 + i h ) (1 + FP f ) 1 The IRP relationship holds when the expected forward premium from the home country s point of view (FP h ): FP h = (1 + i h )/(1 + i f ) 1 S 1 = S 0 * ( 1 + FP h ) 28

29 The Hamburger Standard: Further Discussion

30 30

31 31

Chapter Outline. Chapter Outline. Chapter Outline. Chapter Outline. International Parity Relationships & Forecasting 6 Foreign Exchange Rates

Chapter Outline. Chapter Outline. Chapter Outline. Chapter Outline. International Parity Relationships & Forecasting 6 Foreign Exchange Rates INTERNATIONAL FINANCIAL MANAGEMENT eventh Edition EUN / RENICK International Parity Relationships & Forecasting 6 Foreign Exchange Rates Chapter ix INTERNATIONAL Chapter Objective: FINANCIAL MANAGEMENT

More information

1 Foreign Exchange Markets and Exchange Rates

1 Foreign Exchange Markets and Exchange Rates 1 Foreign Exchange Markets and Exchange Rates 1.1 Exchange Rates: Quotations 1.2 Nominal and Real Exchange Rates 2 The Law of One Price and Purchasing-Power Parity 2.1 Interest Rates and Exchange Rates:

More information

Finance 581: Arbitrage and Purchasing Power Parity Conditions Module 5: Lecture 1 [Speaker: Sheen Liu] [On Screen]

Finance 581: Arbitrage and Purchasing Power Parity Conditions Module 5: Lecture 1 [Speaker: Sheen Liu] [On Screen] Finance 581: Arbitrage and Purchasing Power Parity Conditions Module 5: Lecture 1 [Speaker: Sheen Liu] MODULE 5 Arbitrage and Purchasing Power Parity Conditions [Sheen Liu]: Managers of multinational firms,

More information

Solutions: Sample Exam 2: FINA 5500

Solutions: Sample Exam 2: FINA 5500 Short Questions / Problems Section: (88 points) Solutions: Sample Exam 2: INA 5500 Q1. (8 points) The following are direct quotes from the spot and forward markets for pounds, yens and francs, for two

More information

MCQ on International Finance

MCQ on International Finance MCQ on International Finance 1. If portable disk players made in China are imported into the United States, the Chinese manufacturer is paid with a) international monetary credits. b) dollars. c) yuan,

More information

Chap. 7 Parity Conditions and Currency Forecasting. The Law of One Price. The Law of One Price and Purchasing Power Parity. The Law of One Price

Chap. 7 Parity Conditions and Currency Forecasting. The Law of One Price. The Law of One Price and Purchasing Power Parity. The Law of One Price Chap. 7 Parity Conditions and Currency Forecasting Forecasts based on the Law of One Price. Forecasts based on Relative Purchasing Power Parity. Inflation and the Real Rate of Interest Forecasts based

More information

Foreign Exchange Market: Chapter 7. Chapter Objectives & Lecture Notes FINA 5500

Foreign Exchange Market: Chapter 7. Chapter Objectives & Lecture Notes FINA 5500 Foreign Exchange Market: Chapter 7 Chapter Objectives & Lecture Notes FINA 5500 Chapter Objectives: FINA 5500 Chapter 7 / FX Markets 1. To be able to interpret direct and indirect quotes in the spot market

More information

2. Discuss the implications of the interest rate parity for the exchange rate determination.

2. Discuss the implications of the interest rate parity for the exchange rate determination. CHAPTER 6 INTERNATIONAL PARITY RELATIONSHIPS AND FORECASTING FOREIGN EXCHANGE RATES SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Give a full definition of arbitrage.

More information

The relationship between exchange rates, interest rates. In this lecture we will learn how exchange rates accommodate equilibrium in

The relationship between exchange rates, interest rates. In this lecture we will learn how exchange rates accommodate equilibrium in The relationship between exchange rates, interest rates In this lecture we will learn how exchange rates accommodate equilibrium in financial markets. For this purpose we examine the relationship between

More information

CHAPTER 7 SUGGESTED ANSWERS TO CHAPTER 7 QUESTIONS

CHAPTER 7 SUGGESTED ANSWERS TO CHAPTER 7 QUESTIONS INSTRUCTOR S MANUAL: MULTINATIONAL FINANCIAL MANAGEMENT, 9 TH ED. CHAPTER 7 SUGGESTED ANSWERS TO CHAPTER 7 QUESTIONS 1. Answer the following questions based on data in Exhibit 7.5. a. How many Swiss francs

More information

Chapter Organization

Chapter Organization Chapter Organization Introduction Exchange Rates and International Transactions The Foreign Exchange Market The Demand for Foreign Currency Assets Equilibrium in the Foreign Exchange Market Interest Rates,

More information

Foreign Exchange (FX) market - Introduction

Foreign Exchange (FX) market - Introduction Foreign Exchange (FX) market - Introduction Ruichang LU ( 卢瑞昌 ) Department of Finance Guanghua School of Management Peking University The Foreign Exchange (forex) Market The forex market is the physical

More information

Relationships among Inflation, Interest Rates, and Exchange Rates. J. Gaspar: Adapted from Jeff Madura, International Financial Management

Relationships among Inflation, Interest Rates, and Exchange Rates. J. Gaspar: Adapted from Jeff Madura, International Financial Management Chapter8 Relationships among Inflation, Interest Rates, and Exchange Rates J. Gaspar: Adapted from Jeff Madura, International Financial Management 8. 1 International Finance Theories (cont) Purchasing

More information

Chapter Review and Self-Test Problems

Chapter Review and Self-Test Problems CHAPTER 22 International Corporate Finance 771 3. The fundamental relationships between international financial variables: a. Absolute and relative purchasing power parity, PPP b. Interest rate parity,

More information

Business 4079. Assignment 2 Suggested Answers. 1. Describe how the following transactions are recorded in the balance of payments.

Business 4079. Assignment 2 Suggested Answers. 1. Describe how the following transactions are recorded in the balance of payments. Business 079 Assignment 2 Suggested Answers. Describe how the following transactions are recorded in the balance of payments. (a) A Hong Kong resident, who owns a house valued at C$500,000, migrates to

More information

Chapter 13. Exchange Rates and the Foreign Exchange Market: An Asset Approach. Slides prepared by Thomas Bishop

Chapter 13. Exchange Rates and the Foreign Exchange Market: An Asset Approach. Slides prepared by Thomas Bishop Chapter 13 Exchange Rates and the Foreign Exchange Market: An Asset Approach Slides prepared by Thomas Bishop Preview The basics of exchange rates Exchange rates and the prices of goods The foreign exchange

More information

The Market for Foreign Exchange

The Market for Foreign Exchange The Market for Foreign Exchange Chapter Objective: 5 Chapter Five This chapter introduces the institutional framework within which exchange rates are determined. It lays the foundation for much of the

More information

Price Levels and the Exchange Rate in the Long Run Chapter 15

Price Levels and the Exchange Rate in the Long Run Chapter 15 Price Levels and the Exchange Rate in the Long Run Chapter 15 Prepared by Iordanis Petsas To Accompany International Economics: Theory and Policy, Sixth Edition by Paul R. Krugman and Maurice Obstfeld

More information

Practice Exam 3 Fall 2015

Practice Exam 3 Fall 2015 Global Macroeconomics ::Solutions:: Practice Exam 3 Fall 2015 Do not open this exam until instructed to do so. You have 75 minutes to complete this exam You may use a calculator; you may not use any other

More information

Chapter 14 Foreign Exchange Markets and Exchange Rates

Chapter 14 Foreign Exchange Markets and Exchange Rates Chapter 14 Foreign Exchange Markets and Exchange Rates International transactions have one common element that distinguishes them from domestic transactions: one of the participants must deal in a foreign

More information

CHAPTER 27. Multinational Financial Management

CHAPTER 27. Multinational Financial Management CHAPTER 27 Multinational Financial Management 1 Topics in Chapter Factors that make multinational financial management different Exchange rates and trading International monetary system International financial

More information

Sample Quiz 1 International Finance Management C Total points: 20, Time: 20 min

Sample Quiz 1 International Finance Management C Total points: 20, Time: 20 min Sample Quiz 1 International Finance Management C45.0030.001 Total points: 20, Time: 20 min Q I. (3 points) (answer only one of the three questions): 1. Define & give example of a Pass-Through The degree

More information

Money, Interest Rates, and Exchange Rates in the SHORT RUN. Copyright 2015 Pearson Education, Inc. All rights reserved. 1-1

Money, Interest Rates, and Exchange Rates in the SHORT RUN. Copyright 2015 Pearson Education, Inc. All rights reserved. 1-1 Money, Interest Rates, and Exchange Rates in the SHORT RUN Copyright 2015 Pearson Education, Inc. All rights reserved. 1-1 Preview What is money? Control of the supply of money The willingness to hold

More information

Chapter 17 Appendix A

Chapter 17 Appendix A The Interest Parity Condition Chapter 17 Appendix A We can derive all of the results in the text with a concept that is widely used in international finance. The interest parity condition shows the relationship

More information

Instructions and Guide for Carry Trade and Interest Rate Parity Lab

Instructions and Guide for Carry Trade and Interest Rate Parity Lab Instructions and Guide for Carry Trade and Interest Rate Parity Lab FINC413 Lab c 2014 Paul Laux and Huiming Zhang 1 Introduction 1.1 Overview In the lab, you will use Bloomberg to explore issues concerning

More information

Exchange Rates Revised: January 9, 2008

Exchange Rates Revised: January 9, 2008 Global Economy Chris Edmond Exchange Rates Revised: January 9, 2008 Exchange rates (currency prices) are a central element of most international transactions. When Heineken sells beer in the US, its euro

More information

Quotations. Nominal exchange rate. Examples of appreciation. Currency appreciation. Currency depreciation. Examples of depreciation

Quotations. Nominal exchange rate. Examples of appreciation. Currency appreciation. Currency depreciation. Examples of depreciation Nominal exchange rate The nominal exchange rate between two currencies is the price of one currency in terms of the other. The nominal exchange rate (or, simply, exchange rate) will be denoted by the letter

More information

Determinants of FX Rates: Chapter 2. Chapter Objectives & Lecture Notes FINA 5500

Determinants of FX Rates: Chapter 2. Chapter Objectives & Lecture Notes FINA 5500 Determinants of FX Rates: Chapter 2 Chapter Objectives & Lecture Notes FINA 5500 Chapter Objectives: FINA 5500 Chapter 2 / Determinants of Exchange Rates 1. To be able to explain in your own words why

More information

Long term exchange rate and inflation

Long term exchange rate and inflation International Finance Master in International Economic Policy Long term exchange rate and inflation Lectures 5 Nicolas Coeurdacier nicolas.coeurdacier@sciences-po.fr Motivation and roadmap What are the

More information

Introduction to Exchange Rates and the Foreign Exchange Market

Introduction to Exchange Rates and the Foreign Exchange Market Introduction to Exchange Rates and the Foreign Exchange Market 2 1. Refer to the exchange rates given in the following table. Today One Year Ago June 25, 2010 June 25, 2009 Country Per $ Per Per Per $

More information

CHAPTER 23: FUTURES, SWAPS, AND RISK MANAGEMENT

CHAPTER 23: FUTURES, SWAPS, AND RISK MANAGEMENT CHAPTER 23: FUTURES, SWAPS, AND RISK MANAGEMENT PROBLEM SETS 1. In formulating a hedge position, a stock s beta and a bond s duration are used similarly to determine the expected percentage gain or loss

More information

Homework 1 Solution. Chapter 3

Homework 1 Solution. Chapter 3 Homework 1 Solution Chapter 3 1. Suppose the Canadian dollar is currently traded at C$ 1.40/$. The Deutsche mark is traded at DM 1.39/$. Ignoring transaction costs: a. Determine the C$/DM exchange rate

More information

International Economics Fall 2011 Exchange Rate Determination, Part 2. Paul Deng Sept. 29 & Oct. 4, 2011

International Economics Fall 2011 Exchange Rate Determination, Part 2. Paul Deng Sept. 29 & Oct. 4, 2011 International Economics Fall 2011 Exchange Rate Determination, Part 2 Paul Deng Sept. 29 & Oct. 4, 2011 1 What to Do With The Huge Trade Surplus? China s FX reserves reached $3.2 trillion in 2011 70% of

More information

International Finance

International Finance International Finance CHAPTER34 C H A P T E R C H E C K L I S T When you have completed your study of this chapter, you will be able to 1 Describe a country s balance of payments accounts and explain what

More information

EconS 327 Review for Test 2

EconS 327 Review for Test 2 Test 2 is scheduled for Friday, April 23 rd. Test 2 has 40 multiple choice questions. Test 2 will cover the material assigned during weeks 9-14. This includes o Text: Chapters 10, 12, 13, 14, 15, and 16.

More information

Foreign Exchange Exposure and Risk Management

Foreign Exchange Exposure and Risk Management CHAPTER 12 Foreign Exchange Exposure and Risk Management BASIC CONCEPTS AND FORMULAE 1. Foreign Exchange Market The foreign exchange market is the market in which individuals, firms and banks buy and sell

More information

Seminar. Global Foreign Exchange Markets Chapter 9. Copyright 2013 Pearson Education. 20 Kasım 13 Çarşamba

Seminar. Global Foreign Exchange Markets Chapter 9. Copyright 2013 Pearson Education. 20 Kasım 13 Çarşamba Seminar Global Foreign Exchange Markets Chapter 9 9- Learning Objectives To learn the fundamentals of foreign exchange To identify the major characteristics of the foreign-exchange market and how governments

More information

International Parity Relationships and Forecasting Foreign Exchange Rates

International Parity Relationships and Forecasting Foreign Exchange Rates CHAPTER 6 International Parity Forecasting Foreign CHAPTER OUTLINE Interest Rate Parity Covered Interest Arbitrage Interest Rate Parity and Exchange Rate Determination Reasons for Deviations from Interest

More information

12/03/2012. Currencies and Exchange Rates

12/03/2012. Currencies and Exchange Rates The Canadian dollar is one of 100s of different monies. The three big monies: the U.S. dollar, yen, and euro. In February 2007, one Canadian dollar bought 85 U.S. cents. By November 2007, the Canadian

More information

Chapter 21. International Cash Management. Lecture Outline

Chapter 21. International Cash Management. Lecture Outline Chapter 21 International Cash Management Lecture Outline Multinational Management of Working Capital Subsidiary Expenses Subsidiary Revenue Subsidiary Dividend Payments Subsidiary Liquidity Management

More information

YOU SHOULD HAVE 8 PAGES FOR THIS EXAM. EXAM WILL END AT 2:30. MAKE SURE YOUR NAME IS ON THE FIRST AND LAST PAGE OF THE EXAM.

YOU SHOULD HAVE 8 PAGES FOR THIS EXAM. EXAM WILL END AT 2:30. MAKE SURE YOUR NAME IS ON THE FIRST AND LAST PAGE OF THE EXAM. Econ 380: International Economics Winter 2001 Final Exam Point Value: 100 points Name (ID#) YOU SHOULD HAVE 8 PAGES FOR THIS EXAM. EXAM WILL END AT 2:30. MAKE SURE YOUR NAME IS ON THE FIRST AND LAST PAGE

More information

Forward exchange rates

Forward exchange rates Forward exchange rates The forex market consists of two distinct markets - the spot foreign exchange market (in which currencies are bought and sold for delivery within two working days) and the forward

More information

Midterm - Economics 160B, Fall 2014

Midterm - Economics 160B, Fall 2014 Name Student ID Section (or TA) Please indicate on your scantron Test Form A. Midterm - Economics 160B, Fall 2014 You will have 75 minutes to complete this exam. Record answers for all multiple choice

More information

International Finance Master PEI Nicolas Coeurdacier. Sample exam

International Finance Master PEI Nicolas Coeurdacier. Sample exam International Finance Master PEI Nicolas Coeurdacier Sample exam Documents and calculator not allowed. For the essay questions, please be precise but concise in your answers. I. Multiple choice questions

More information

Economics 345 Practice Examination. This exam has two parts. Part I is worth 30 points, Part II is worth 20 points.

Economics 345 Practice Examination. This exam has two parts. Part I is worth 30 points, Part II is worth 20 points. Spring 2004 Mr. Easton Economics 345 Practice Examination This exam has two parts. Part I is worth 30 points, Part II is worth 20 points. Part I. Answer the following questions by writing the question

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A fall in the Canadian-dollar price of foreign currency is A) a loss in the relative

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Chatper 34 International Finance - Test Bank MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The currency used to buy imported goods is A) the

More information

Currency Spot Markets and Forward Exchange Rates

Currency Spot Markets and Forward Exchange Rates Currency Spot Markets and Forward Exchange Rates International Finance 02 Outline 1. Exchange Rate Markets 2. Spot Exchange 3. Forward Exchange Rates 1 Some Definitions Definition of exchange rate: An

More information

6. Foreign Currency Options

6. Foreign Currency Options 6. Foreign Currency Options So far, we have studied contracts whose payoffs are contingent on the spot rate (foreign currency forward and foreign currency futures). he payoffs from these instruments are

More information

Capital Markers Section 1 Foreign Exchange Markets

Capital Markers Section 1 Foreign Exchange Markets Πανεπιστήμιο Πειραιώς, Τμήμα Τραπεζικής και Χρηματοοικονομικής Διοικητικής Μεταπτυχιακό Πρόγραμμα «Χρηματοοικονομική Ανάλυση για Στελέχη» Capital Markers Section 1 Foreign Exchange Markets Michail Anthropelos,

More information

Chapter 16: Financial Risk Management

Chapter 16: Financial Risk Management Chapter 16: Financial Risk Management Introduction Overview of Financial Risk Management in Treasury Interest Rate Risk Foreign Exchange (FX) Risk Commodity Price Risk Managing Financial Risk The Benefits

More information

Practice Set and Solutions #1

Practice Set and Solutions #1 Bo Sjö 2012-10-03 Practice Set and Solutions #1 What to do with this practice set? 1 Practice sets are handed out to help students master the material of the course and prepare for the final exam. These

More information

What Determines Exchange Rates? In the Short Run In the Long Run

What Determines Exchange Rates? In the Short Run In the Long Run What Determines Exchange Rates? In the Short Run In the Long Run Selected Exchange Rates Selected Exchange Rates Determinants of the Exchange Rate in the Short Run In the short run, movements of currency

More information

What you will learn: UNIT 3. Traditional Flow Model. Determinants of the Exchange Rate

What you will learn: UNIT 3. Traditional Flow Model. Determinants of the Exchange Rate What you will learn: UNIT 3 Determinants of the Exchange Rate (1) Theories of how inflation, economic growth and interest rates affect the exchange rate (2) How trade patterns affect the exchange rate

More information

INTERNATIONAL FINANCE AND EXCHANGE RATES

INTERNATIONAL FINANCE AND EXCHANGE RATES INTERNATIONAL FINANCE AND EXCHANGE RATES CHAPTER 16 1 CHAPTER OUTLINE International Financial Transactions Foreign Exchange Markets Alternative Foreign Exchange Systems 2 YOU ARE HERE 3 CURRENCY In the

More information

INTRODUCTION TO THE FX MARKET MAREN ROMSTAD, BLINDERN, 31ST OCTOBER

INTRODUCTION TO THE FX MARKET MAREN ROMSTAD, BLINDERN, 31ST OCTOBER INTRODUCTION TO THE FX MARKET MAREN ROMSTAD, MRO@NBIM.NO BLINDERN, 31ST OCTOBER Agenda Market characteristics Basic theories and models Investment strategies The currency basket of NBIM MARKET CHARACTERISTICS

More information

Slides for Krugman and Obstfeld Chapter 13

Slides for Krugman and Obstfeld Chapter 13 Slides for Krugman and Obstfeld Chapter 13 Alan G. Isaac American University 2010-09-10 Preview Introduction to Exchange Rates Introductory Concepts International Financial Markets Basics exchange rate

More information

Theories of Exchange rate determination

Theories of Exchange rate determination Theories of Exchange rate determination INTRODUCTION By definition, the Foreign Exchange Market is a market 1 in which different currencies can be exchanged at a specific rate called the foreign exchange

More information

ARBITRAGE AND PARITY CONDITIONS

ARBITRAGE AND PARITY CONDITIONS BSc Financial Economics: International Finance Lecture 2, Part 2 Autumn 2013 Anne Sibert 2013. ARBITRAGE AND PARITY CONDITIONS I. TRIANGULAR ARBITRAGE Triangular Arbitrage involves exploiting a price discrepancy

More information

Practice Problems on Exchange Rates

Practice Problems on Exchange Rates Practice Problems on Exchange Rates 1- Define nominal exchange rate and real exchange rate. How are changes in the real exchange rate and the nominal exchange rate related? The nominal exchange rate is

More information

To appear as an entry in the Concise Encyclopedia of Economics, Liberty Fund, Inc., edited by David Henderson.

To appear as an entry in the Concise Encyclopedia of Economics, Liberty Fund, Inc., edited by David Henderson. Foreign exchange Jeffrey A. Frankel September 2005 To appear as an entry in the Concise Encyclopedia of Economics, Liberty Fund, Inc., edited by David Henderson. The foreign exchange market is the market

More information

2. Exercising the option - buying or selling asset by using option. 3. Strike (or exercise) price - price at which asset may be bought or sold

2. Exercising the option - buying or selling asset by using option. 3. Strike (or exercise) price - price at which asset may be bought or sold Chapter 21 : Options-1 CHAPTER 21. OPTIONS Contents I. INTRODUCTION BASIC TERMS II. VALUATION OF OPTIONS A. Minimum Values of Options B. Maximum Values of Options C. Determinants of Call Value D. Black-Scholes

More information

This act of setting a price today for a transaction in the future, hedging. hedge currency exposure, short long long hedge short hedge Hedgers

This act of setting a price today for a transaction in the future, hedging. hedge currency exposure, short long long hedge short hedge Hedgers Section 7.3 and Section 4.5 Oct. 7, 2002 William Pugh 7.3 Example of a forward contract: In May, a crude oil producer gets together with a refiner to agree on a price for crude oil. This price is for crude

More information

Monetary Policy Bank of Canada

Monetary Policy Bank of Canada Bank of Canada The objective of monetary policy may be gleaned from to preamble to the Bank of Canada Act of 1935 which says, regulate credit and currency in the best interests of the economic life of

More information

Arbitrage. In London: USD/GBP 0.645 In New York: USD/GBP 0.625.

Arbitrage. In London: USD/GBP 0.645 In New York: USD/GBP 0.625. Arbitrage 1. Exchange rate arbitrage Exchange rate arbitrage is the practice of taking advantage of inconsistent exchange rates in different markets by selling in one market and simultaneously buying in

More information

The Market for Foreign Exchange

The Market for Foreign Exchange INTERNATIONAL FINANCIAL MANAGEMENT Fourth Edition EUN / RESNICK 5-0 The Market for Foreign Exchange Chapter Objectives: 5-1 5 Chapter Five INTERNATIONAL FINANCIAL MANAGEMENT This chapter serves to introduce

More information

CHAPTER 3. Arbitrage and Financial Decision Making. Chapter Synopsis

CHAPTER 3. Arbitrage and Financial Decision Making. Chapter Synopsis CHAPTER 3 Arbitrage and Financial Decision Making Chapter Synopsis 3.1 Valuing Decisions When considering an investment opportunity, a financial manager must systematically compare the costs and benefits

More information

Four steps to making your first trade

Four steps to making your first trade Four steps to making your first trade AN INTRODUCTION TO TRADING CURRENCIES A FOREX.com educational guide FOREX.com is a trading name of GAIN Capital - FOREX.com Canada Limited is a member of the Investment

More information

International Financial Markets/1. Prof. Ian Giddy. What are the Global Financial Markets?

International Financial Markets/1. Prof. Ian Giddy. What are the Global Financial Markets? International Financial Markets/1 International Financial Markets Prof. Ian Giddy Stern School of Business, New York University What are the Global Financial Markets? The Foreign Exchange Market Eurocurrency

More information

1/24/2010. Definitions of Exchange Rates PP542. Depreciation and Appreciation. Exchange Rate Quotations. Depreciation and Appreciation (cont.

1/24/2010. Definitions of Exchange Rates PP542. Depreciation and Appreciation. Exchange Rate Quotations. Depreciation and Appreciation (cont. PP542 The Foreign Exchange Market Definitions of Exchange Rates Exchange rates are quoted as foreign currency per unit of domestic currency or domestic currency per unit of foreign currency. How much can

More information

Chapter 9 Parity and Other Option Relationships

Chapter 9 Parity and Other Option Relationships Chapter 9 Parity and Other Option Relationships Question 9.1. This problem requires the application of put-call-parity. We have: Question 9.2. P (35, 0.5) C (35, 0.5) e δt S 0 + e rt 35 P (35, 0.5) $2.27

More information

Open-Economy Macroeconomics: Basic Concepts. Open-Economy Macroeconomics: Basic Concepts Open and Closed Economies

Open-Economy Macroeconomics: Basic Concepts. Open-Economy Macroeconomics: Basic Concepts Open and Closed Economies In this chapter, look for the answers to these questions: 3 Open-Economy Macroeconomics: Basic Concepts How are international flows of goods and assets related? What s the difference between the real and

More information

Chapter 2 (a) How Exchange Rates Change. Equilibrium Exchange Rates. The two-currency model: $ vs. Really the $ vs. all other forex.

Chapter 2 (a) How Exchange Rates Change. Equilibrium Exchange Rates. The two-currency model: $ vs. Really the $ vs. all other forex. Chapter 2 (a) The Determination of Floating Exchange Rates: how markets set the equilibrium exchange rates also Currency depreciation and appreciation SETTING THE EQUILIBRIUM Exchange Rates are based on

More information

3. a. If all money is held as currency, then the money supply is equal to the monetary base. The money supply will be $1,000.

3. a. If all money is held as currency, then the money supply is equal to the monetary base. The money supply will be $1,000. Macroeconomics ECON 2204 Prof. Murphy Problem Set 2 Answers Chapter 4 #2, 3, 4, 5, 6, 7, and 9 (on pages 102-103) 2. a. When the Fed buys bonds, the dollars that it pays to the public for the bonds increase

More information

Exchange Rates. Costas Arkolakis teaching fellow: Federico Esposito. January 2014. Economics 407, Yale

Exchange Rates. Costas Arkolakis teaching fellow: Federico Esposito. January 2014. Economics 407, Yale Exchange Rates Costas Arkolakis teaching fellow: Federico Esposito Economics 407, Yale January 2014 Outline De nitions: Nominal and Real Exchange Rate A Theory of Determination of the Real Exchange Rate

More information

Untangling F9 terminology

Untangling F9 terminology Untangling F9 terminology Welcome! This is not a textbook and we are certainly not trying to replace yours! However, we do know that some students find some of the terminology used in F9 difficult to understand.

More information

Exchange Rates. Chapter 14

Exchange Rates. Chapter 14 Exchange Rates Chapter 14 Basics Definition Direct (American) dollar price of foreign currency = dollars/foreign currency Indirect (European) foreign currency price of domestic currency = foreign currency/dollar

More information

Paper F9. Financial Management. Friday 7 June 2013. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants.

Paper F9. Financial Management. Friday 7 June 2013. Fundamentals Level Skills Module. The Association of Chartered Certified Accountants. Fundamentals Level Skills Module Financial Management Friday 7 June 2013 Time allowed Reading and planning: Writing: 15 minutes 3 hours ALL FOUR questions are compulsory and MUST be attempted. Formulae

More information

CHAPTER 9 INTERNATIONAL FINANCIAL MARKETS

CHAPTER 9 INTERNATIONAL FINANCIAL MARKETS CHAPTER 9 INTERNATIONAL FINANCIAL MARKETS LEARNING OBJECTIVES: 1. Discuss the purposes, development, and financial centers of the international capital market. 2. Describe the international bond, international

More information

Lecture 5: Put - Call Parity

Lecture 5: Put - Call Parity Lecture 5: Put - Call Parity Reading: J.C.Hull, Chapter 9 Reminder: basic assumptions 1. There are no arbitrage opportunities, i.e. no party can get a riskless profit. 2. Borrowing and lending are possible

More information

FIN 683 Financial Institutions Management Foreign-Currency Risk

FIN 683 Financial Institutions Management Foreign-Currency Risk FIN 683 Financial Institutions Management Foreign-Currency Risk Professor Robert B.H. Hauswald Kogod School of Business, AU Global Banks Globalization of financial markets has increased foreign exposure

More information

Mechanics of Foreign Exchange - money movement around the world and how different currencies will affect your profit

Mechanics of Foreign Exchange - money movement around the world and how different currencies will affect your profit Dear Business Leader, Welcome to the Business Insight Seminars an exclusive, informational series to help you gain a powerful edge in today s highly competitive business environment. Our first topic in

More information

International Finance Prof. A. K. Misra Department of Management Indian Institute of Technology, Kharagpur

International Finance Prof. A. K. Misra Department of Management Indian Institute of Technology, Kharagpur International Finance Prof. A. K. Misra Department of Management Indian Institute of Technology, Kharagpur Lecture - 16 Transaction Exposure Management Good morning. Let us move to the session 16, where

More information

Thank You for Attention

Thank You for Attention Thank You for Attention Explain how the foreign exchange market works. Examine the forces that determine exchange rates. Consider whether it is possible to predict future rates movements. Map the business

More information

Chapter 4 - The Foreign Exchange Market. Functions of the FX Market

Chapter 4 - The Foreign Exchange Market. Functions of the FX Market Chapter 4 - The Foreign Exchange Market Market Structure and Roles Volume and distribution by Country, Currencies Who trades with Whom Introduction to different kinds of Foreign Exchange contracts Spot,

More information

Introduction to Exchange Rates and the Foreign Exchange Market

Introduction to Exchange Rates and the Foreign Exchange Market Introduction to Exchange Rates and the Foreign Exchange Market 2 1. Exchange Rate Essentials 2. Exchange Rates in Practice 3. The Market for Foreign Exchange 4. Arbitrage and Spot Exchange Rates 5. Arbitrage

More information

Assignment 10 (Chapter 11)

Assignment 10 (Chapter 11) Assignment 10 (Chapter 11) 1. Which of the following tends to cause the U.S. dollar to appreciate in value? a) An increase in U.S. prices above foreign prices b) Rapid economic growth in foreign countries

More information

PRINCIPLES OF MACROECONOMICS. Chapter 31 Open Economy Macroeconomics

PRINCIPLES OF MACROECONOMICS. Chapter 31 Open Economy Macroeconomics PRINCIPLES OF MACROECONOMICS Chapter 31 Open Economy Macroeconomics Overview In this chapter we introduce open-economy macroeconomics and examine the importance of international trade (exports and imports

More information

J. Gaspar: Adapted from Jeff Madura International Financial Management

J. Gaspar: Adapted from Jeff Madura International Financial Management Chapter3 International Financial Markets J. Gaspar: Adapted from Jeff Madura International Financial Management 3-1 International Financial Markets Can be segmented as follows: 1.The Foreign Exchange Market

More information

Chapter 9. Forecasting Exchange Rates. Lecture Outline. Why Firms Forecast Exchange Rates

Chapter 9. Forecasting Exchange Rates. Lecture Outline. Why Firms Forecast Exchange Rates Chapter 9 Forecasting Exchange Rates Lecture Outline Why Firms Forecast Exchange Rates Forecasting Techniques Technical Forecasting Fundamental Forecasting Market-Based Forecasting Mixed Forecasting Forecasting

More information

Determination of Forward and Futures Prices. Chapter 5

Determination of Forward and Futures Prices. Chapter 5 Determination of Forward and Futures Prices Chapter 5 Fundamentals of Futures and Options Markets, 8th Ed, Ch 5, Copyright John C. Hull 2013 1 Consumption vs Investment Assets Investment assets are assets

More information

Assignment 4. To answer each question correctly, you have to choose the best answer from the given four choices.

Assignment 4. To answer each question correctly, you have to choose the best answer from the given four choices. IBS 601 Introduction to International Economics Instructor: Sharif F. Khan Department of Economics Ryerson University Winter 2006 Assignment 4 Part A Multiple-Choice Questions To answer each question correctly,

More information

Your Guide to Foreign Exchange. Strategies for managing risk and making payments worldwide.

Your Guide to Foreign Exchange. Strategies for managing risk and making payments worldwide. Your Guide to Foreign Exchange Strategies for managing risk and making payments worldwide. Contents Capitalizing on global opportunities... 1 Bringing the benefits of FX to your business... 2 Integrating

More information

Chapter 5 Financial Forwards and Futures

Chapter 5 Financial Forwards and Futures Chapter 5 Financial Forwards and Futures Question 5.1. Four different ways to sell a share of stock that has a price S(0) at time 0. Question 5.2. Description Get Paid at Lose Ownership of Receive Payment

More information

Module - 16 Exchange Rate Arithmetic: Cross Rates & Triangular Arbitrage

Module - 16 Exchange Rate Arithmetic: Cross Rates & Triangular Arbitrage Module - 16 Exchange Rate Arithmetic: Cross Rates & Triangular Arbitrage Developed by: Dr. Prabina Rajib Associate Professor Vinod Gupta School of Management IIT Kharagpur, 721 302 Email: prabina@vgsom.iitkgp.ernet.in

More information

CA Final Course Paper 2 Strategic Financial Management Chapter 12. CA. Rajiv Singh

CA Final Course Paper 2 Strategic Financial Management Chapter 12. CA. Rajiv Singh CA Final Course Paper 2 Strategic Financial Management Chapter 12 CA. Rajiv Singh 1.1 Introduction Forex Market 1.2 Forex Market in India 1.3 Merchant Deal Structure 1.4 Inter bank Quote 1.5 Forex Quote

More information

SOLUTION1. exercise 1

SOLUTION1. exercise 1 exercise 1 Stock BBB has a spot price equal to 80$ and a dividend equal to 10$ will be paid in 5 months. The on year interest rate is equal to 8% (c.c). 1. Calculate the 6 month forward price? 2. Calculate

More information

15.012 Applied Macro and International Economics. Alberto Cavallo. February 2011

15.012 Applied Macro and International Economics. Alberto Cavallo. February 2011 Exchange Rt Rates 15.012 Applied Macro and International Economics Alberto Cavallo February 2011 Class Outline Nominal exchange rates E Short run: market for local currency Interest rate parity Long run:

More information

Currency Futures and Forward Contracts

Currency Futures and Forward Contracts Currency Futures and Forward Contracts by Geneviève Payette presented to Gregor Smith Queen s University January 28, 2005 In the past 30 years exchange rates have become much more volatile and less predictable

More information

Chapter 4.1. Intermarket Relationships

Chapter 4.1. Intermarket Relationships 1 Chapter 4.1 Intermarket Relationships 0 Contents INTERMARKET RELATIONSHIPS The forex market is the largest global financial market. While no other financial market can compare to the size of the forex

More information