Surprise rate hike - currency appreciates - CFAI Example 8 - Q2

[JJ1337]

Hey @ all,
the solution of the above-mentioned example states that if a surprise rate hike in one country happens, the currency of that country is likely to rise. I understand this reasoning (thinking of capitel inflows to that currency or like the logic of the carry trade, respectively).
My question: if I would assume that the (un)covered interest parity holds, the effect should be “vice versa”, shouldn’t it? Second, should we always assume that the (un)covered interest parity does not hold when it comes to the exam?
Thanks!

 

[ABAL]

Surprise rate hike as in Interest rate hike. If that be so, then it is instantenous ..is not it? How can UIP or CIP hold in either of the case?
However CIP (or in rare case when UIP may have chance of holding) will force it back to equilibrium. That’s logic. And when that does not happen Carry Trade happens.
Taylor Rule is equally helpful in this but you need to watch out for the key word here. Whether the rate hike is “nominal” or “real”. If real then that would go on to increase the currency value anyway.
Hope the above suffice

 

[S2000magician]

Interest rate parity and market demand for currencies usually have opposite effects on the currency exchange rate.

 

[ABAL]

Right sir and if not mistaken that is genesis of carry trade I believe.

 

[S2000magician]

I hadn’t thought about it before, but you may be correct. Seems reasonable.

 

[JJ1337]

To sum up: ‘cause as it is stated as an interest rate hike, the focus of the question is short-tern and the CIRP holds only in the long-run. Therefore, the carry trade logic is appropriate. Right?