Description
The PPT explaining about Interest Rates Parity of two Countries effect on Forward Rates .
Interest Rates Parity of two Countries effect on Forward Rates
Without Interest With Interest Rate Parity Rate Parity
You have $800,000 to invest 90 days interest rate in USA 2% 90 days interest rate in UK 4%
1. Convert $ to pounds
Spot Rate:$1.60 Forward Rate:$1.60
Spot rate: $1.60 Forward Rate: $1.569
£500,000 ($800,000/1.60)
£500,000 ($800,000/1.60) £520,000
2.
Sell Euro 90 day forward contact £520,000 and invest pounds in UK bank @4%
3.
Convert the £ to $
$832,000 (@ 1.60 per £)
$816,000 (@1.569 per £)
4.
Rate of Return
4%
2%
?
Interest rate Parity :The size of the forward premium (or discount) should be equal to the interest rate differential between the two countries of concern.
Any interest advantage will be offset by the discount on forward rate. An arbitrage would generate a return that is no higher than what would have been generated by a domestic investment. Back
?
?
Derivation of Interest Rate Parity
P= ( 1+ih/1+if P=(1+ih/1+if)-1) – 1
Where
p=forward premium (or discount) ih=Interest Rate on Home Deposit if=Interest Rate on Foreign Deposit Interest Rate USA(Home)=2% UK(Foreign)=4%
p= (1+0.02/1+0.04)-1 = -1.92%(Discount Rate) F= S(1+p) F= 1.60(1-0.0192) =1.569
USA investor would receive 1.92% less when selling Pounds after 90 days based on forward contract than the price they pay for Pounds today at spot Rate.
Thank You.
References:
Options,Futures,and Other Derivatives-John C.Hull International Corporate Finance-Madura
doc_927453156.pptx
The PPT explaining about Interest Rates Parity of two Countries effect on Forward Rates .
Interest Rates Parity of two Countries effect on Forward Rates
Without Interest With Interest Rate Parity Rate Parity
You have $800,000 to invest 90 days interest rate in USA 2% 90 days interest rate in UK 4%
1. Convert $ to pounds
Spot Rate:$1.60 Forward Rate:$1.60
Spot rate: $1.60 Forward Rate: $1.569
£500,000 ($800,000/1.60)
£500,000 ($800,000/1.60) £520,000
2.
Sell Euro 90 day forward contact £520,000 and invest pounds in UK bank @4%
3.
Convert the £ to $
$832,000 (@ 1.60 per £)
$816,000 (@1.569 per £)
4.
Rate of Return
4%
2%
?
Interest rate Parity :The size of the forward premium (or discount) should be equal to the interest rate differential between the two countries of concern.
Any interest advantage will be offset by the discount on forward rate. An arbitrage would generate a return that is no higher than what would have been generated by a domestic investment. Back
?
?
Derivation of Interest Rate Parity
P= ( 1+ih/1+if P=(1+ih/1+if)-1) – 1
Where
p=forward premium (or discount) ih=Interest Rate on Home Deposit if=Interest Rate on Foreign Deposit Interest Rate USA(Home)=2% UK(Foreign)=4%
p= (1+0.02/1+0.04)-1 = -1.92%(Discount Rate) F= S(1+p) F= 1.60(1-0.0192) =1.569
USA investor would receive 1.92% less when selling Pounds after 90 days based on forward contract than the price they pay for Pounds today at spot Rate.
Thank You.
References:
Options,Futures,and Other Derivatives-John C.Hull International Corporate Finance-Madura
doc_927453156.pptx