Chapter 6: Interest Rate Parity
Power Points created by:
Joseph F. Greco Ph. D.
California State University, Fullerton
Mihaylo College of Business and Economics
Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
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Chapter 6: Interest Rate Parity
6.1
The Theory of Covered Interest Rate Parity
6.2
Covered Interest Rate Parity in Practice
6.3
Problems Related to Testing Interest Rate
Parity
6.4
Hedging Transaction Risk in the Money Market
6.5
The Term Structure of Forward Premiums and
Discounts
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6.1 The Theory of Covered Interest Rate
Parity
The Theory of Covered Interest Rate Parity:
Overview
• The Intuition Behind Interest Rate Parity
• Two Ways to Buy a Currency Forward
• Why There Must Be Interest Rate Parity
• Deriving Interest Rate Parity
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6.1 The Theory of Covered Interest Rate
Parity
• The Intuition Behind Interest Rate Parity
• Two Ways to Buy a Currency Forward
• Why There Must Be Interest Rate Parity
• Deriving Interest Rate Parity
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6.1 The Theory of Covered Interest Rate
Parity
• Two Ways to Buy a Currency Forward
• Buy a forward contract
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6.1 The Theory of Covered Interest Rate
Parity
• Why There Must Be Interest Rate Parity
• Covered interest rate arbitrage
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6.1 The Theory of Covered Interest Rate
Parity
• Deriving Interest Rate Parity
• A general expression for interest rate parity
• Interest rate parity and forward premiums and
discounts
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Exhibit 6.1
Diagram of Covered Interest Arbitrage
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Exhibit 6.2
Kevin Anthony’s Arbitrage
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6.2 Covered Interest Rate Parity in Practice
• The External Currency Market
• Transaction costs in the external currency market
• How the external currency market affects other
capital markets
• London interbank offer rate (LIBOR)
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Exhibit 6.3
Interest Rates in the External Currency Market
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6.2 Covered Interest Rate Parity in Practice
• Covered Interest Arbitrage with
Transaction Costs
– An empirical test
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Exhibit 6.4
Covered Interest Rate Parity with Bid-Ask Rates
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Exhibit 6.5 – Panel A
$/£ Covered Interest Arbitrage into £
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Exhibit 6.5 – Panel B
$/£ Covered Interest Arbitrage into £
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6.3 Problems Related to Testing
Interest Rate Parity
•
•
•
•
Default Risks
Exchange Controls
Political Risk
The Thrilla in Manila
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Exhibit 6.6
External and Internal FRF Interest Rates and Difference
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6.4 Hedging Transaction Risk in the Money
Market
Hedging Transaction Risk - Money Market:
Overview
• Introduction
• Hedging a Foreign Currency Liability
• Hedging a Foreign Currency Receivable
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6.4 Hedging Transaction Risk in the Money
Market
• Introduction
• Synthetic forward
• Money market hedge
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6.4 Hedging Transaction Risk in the Money
Market
• Hedging a Foreign Currency Liability
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6.4 Hedging Transaction Risk in the Money
Market
• Hedging a Foreign Currency Receivable
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6.5 The Term Structure of Forward
Premiums and Discounts
• The Term Structure of Interest Rates
– Spot Interest Rates
– A Review of Bond Pricing
– Yields to Maturity
– Deriving Long-Term Spot Interest Rates
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6.5 The Term Structure of Forward
Premiums and Discounts
• Long-Term Forward Rates and Premiums
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