Currency management - Reading 18

C

crosstheevil

New member
Joined
Jul 6, 2015
Messages
0
Reaction score
0
Let’s assume we have 2 currencies, A & B. Real interest rate in country A is higher than B so demand for currency A is higher (it attracts more foreign capital as per the curriculum), hence, currency A shall appreciate. But the Uncovered IR Parity says otherwise, if interest rate in country A is higher, currency A will depreciate … Can anyone help explain this?
Thanks,
 
There are many forces that influence exchange rates.
Interest rate parity is one, supply and demand is another. They tend to work in opposite directions.
Nothing mysterious.
 
Please correct me if this isnt technically correct, but this is how i understand it.
the total interest rate = real + interest/inflation.
In countries that have rapid inflation, the currency likely is depreciating. hence the money wont buy as much and it will depreciate There is no free lunch here. if the interest goes up, then most likely the buying power will adjust hence removing arbitage opportunity.
The exception to the rule if something happens to cause the real or intrinsic value of the currency to increase.
if that happens, then that would cause its value not to increase because of interest/inflation but because the currency is actually worth more from another influence. hence it grows in value.
hope this helps
 
as far as I have seen from the curriculum, cfai always assume currencies are ‘sticky’ and the carry trade is always possible.
i.e. central banks do look at fx rates to ensure that the real economy (importers/exporters) are not hurt.
so covered/uncovered relationships are just needed to calculate profits.
 
can you share with me where youre reading please
 
onlysimon wrote:
as far as I have seen from the curriculum, cfai always assume currencies are ‘sticky’ and the carry trade is always possible.
i.e. central banks do look at fx rates to ensure that the real economy (importers/exporters) are not hurt.
so covered/uncovered relationships are just needed to calculate profits.
Click to expand...
I think you’re right plus the curriculum also specifically mentions that “high-yield countries often see their currencies APPRECIATE, not depreciate, for extended periods of time …”
 
I dont know if we’re allowed to quote but i noticed in learning outcome 19.d
point 1 is economic fundamentals (currency values will converge to fair value)
and point 3 (carry trade) says that it is a violation of uncovered interest rate parity.
Where is the quote about high yield currencies found?
I agree that there is currency volility ..especially in the short term.
I wish to learn more about what is being discussed about “high yield countries”.
 
1.REAL INTEREST rate in country A is higher than B so demand for currency A is higher….and it will appreciate……
2. If INTEREST RATE(Not Real interest rate) in country A is higher, currency A will depreciate … The assumption is Real Interest rate should be same in the two countries(else money will flow to a country with higher Real interst rate) and difference in interest rate is due to inflation.The country with higher inflation,and hence higher (nominal) interest rate ,should see its currency depreciate.
3.Traders can Borrow in currecny with low interest rate(yield) and invest in “High Yielding Currencies” -both Nominal Rates-to take advantage of arbitrage whereupon interest differential and forward premium are not in agreement:
That is Interest Rate Parity ,as mandated by (1 + i$ )/(1 + iY ) = F/ S,approximated for small interest rate by, i$ − iY = (F − S)/ S ,IS VIOLATED,and taken advantage of.
Of course exchange rate is driven by demand and supply,but demand and supply is driven bymultiple factors,including Interest rates and ,trade.
 
You must log in or register to reply here.
Back
Top