Class Notes (834,991)
Canada (508,850)
Finance (549)
FIN 621 (10)
Lecture

International Finance-lecture3.docx

4 Pages
187 Views
Unlock Document

Department
Finance
Course
FIN 621
Professor
Sergiy Rakhmayil
Semester
Winter

Description
• International Finance-lecture3 IBS 621 • Lecture 3 • Foundations of International Financial Management • Globalization and the Multinational Firm • International Monetary System • Balance of Payments • The Market for Foreign Exchange • International Parity Relationships • International Parity Relations • Interest rate parity • Purchasing power parity • Fisher effect • Using the parity relations in forecasting exchange rates • Interest Rate Parity • F – forward rate, FC/DC • S – spot rate, FC/DC • rFC interest rate of foreign currency (FC) • rDC – interest rate of domestic currency (DC) • Interest Rate Parity • You observe that spot EUR/USD=1.05, one-year interest rates are: r USD=1.76%, r =3.39%, what is the 1-year forward EUR/USD rate? EUR • IRP and Covered Interest Arbitrage • If IRP failed to hold, an arbitrage would exist. It’s 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. • IRP and Covered InterestArbitrage • Alternative 1. Invest $1,000 in Canada @ ___%, in one year investment will be worth $1,071 = $1,000(1+ i ) = $1,000(1.071) • Alternative 2. – Exchange $1,000 for £800 at the going spot rate, (note that £800 = $1,000÷$______/£), – invest £800 in the UK at i = £1.56% for one year, receive £892.48. – Translate £892.48 back into dollars at F ($/£)360$1.20/£, the £892.48 will be exactly $1,071. • Note that payoffs for alternatives 1 and 2 are ________ • IRP and Covered InterestArbitrage • According to IRP only one 360-day forward rate, F ($/£), 360 exist. It must be the case that F 360£) = ____________ • If F360/£)  $1.20/£, riskless arbitrage is possible – As usual, buy low-sell high • Arbitrage Strategy I • If F360/£) > $1.20/£, let’s say _______. Forward GBP overpriced (CAD is underpriced). Sell forward GBP and buy spot GBP to make it riskless. – Borrow $__________ at t = 0 at i = 7.1%.$ – Exchange $1,000 for £_______ at the prevailing spot rate, (note that £800 = $1,000÷$1.25/£) invest £800 at 11.56% (i ) for o£e year to achieve £892.48 – Translate £__________ back into dollars, if F 360£) > $1.20/£ , £892.48 will be more than enough to repay your dollar obligation of $1,071. £892.48 * $1.3 = $1160.22, profit = $_________ • Arbitrage Strategy II • If F 360£) < $1.20/£, let’s say $______. Forward GBP underpriced (CAD overpriced). Buy forward GBP (sell forward CAD), sell spot GBP, get CAD to make it riskless. i. Borrow £_______ at t = 0 at i = 11£56% . ii. Exchange £800 for $______ at the prevailing spot rate, invest $1,000 at 7.1% for one year to achieve $________. iii. Translate $1,071 back into pounds, if F 360£) < $1.20/£ , $1,071 will be more than enough to repay your £ obligation of £892.48. $1,071/$1.10= £973.64, profit = £___________ • IRP and Forward Bid-Ask Spread • F bid* bidr bid,FC(1+r ask,DC • F ask ask* (1+r ask,FC/(1+rbid,DC – F – forward exchange rate, FC/DC – S – spot exchange rate, FC/DC – r bid,FCrask,FCnterest rates on lending (i.e. on your savings account) and borrowing (i.e. if you want to get a loan) in the foreign country – r bid,DC ask,DCending and borrowing interest rates in the home country (country of the currency that is in the denominator in the FC/DC exchange rate) • IRP and Bid-Ask Spread • You see the following rates. Spot USD/EUR=1.1865-70, JPY/USD=108.10-20. The interest rates are: r $5-5.25, r EUR=3.25-3.5, r =JPY5-1.5. What should be the spot JPY/EUR rate and 3-month forward JPY/EUR rates? • IRP and Bid-Ask Spread • Purchasing Power Parity • The exchange rate between two currencies should equal the ratio of the countries’ price levels: • For example, if an ounce of gold costs $300 in the U.S. and £150 in the U.K., then the price of one pound in terms of dollars should be: • Purchasing Power Parity • If the law of one price were true for all goods and services, the purchasing power parity exchange rate can be found from any set of prices. • This is absolute purchasing power parity. • Hamburger standard compares Big Mac prices with the exchange rates to determine whether or not overvaluation or undervaluation exist. • Index introduced by The Economist, shortly after the Bog Mac they introduced the Tall Latte index. Subscription required. They offer free online subscription, try and see the articles. • Purchasing Power Parity • S 0 spot
More Less

Related notes for FIN 621

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit