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interest rates and exchange rates (the details will be shown in instruction)
Finance & Accounting
Pages 6 (1506 words)
INTEREST RATES AND EXCHANGE RATES Table of Content 1. Covered Interest Rate Parity (CIRP) 3 2. Uncovered Interest Rate Parity (UIRP) – Investment in First Country 4 a) Expected Exchange Rate Three Months from Birthday 5 b) Expected Exchange Rate Six Months from Birthday 7 c) Difference between Expected Exchange Rates 7 d) Comparison of Expected Exchange Rates with Cover Interest Rate Parity 8 3) Uncovered Interest Rate Parity (UIRP) – Investment in Second Country 9 a) Gain or Loss from Investment 9 b) Significance of Spreads in FOREX – Arbitrage 10 4) Opportunity for CIRP on Six Month Data 10 References 11 Bibliography 12 1.
This is mainly because of the indifference of the investors. When the interest rate parity is covered, the interest rates and the forward exchange rate between two countries will be in equilibrium. This means that in such equilibrium, each unit return of home currency will be equal to the foreign currency. Thus, the covered interest rate parity states that the forward premium and the interest rate between two countries are equal and there will be no opportunity for arbitrage (Wang, 2009, pp.49-56). (Source: Dollery, University of Hull) The application of covered interest parity is that when it holds true, an investor will be indifferent of investment choice between two countries. For instance, if a French investor has the choice of either to invest or deposit in € or $ then under CIRP, the investor will get same return irrespective of choice of currency. This is because in equilibrium the future value of investment or deposit will be same for both the currencies (Johann, 2008, p.10). ...
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