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R
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Showing no prejudice for or against something; impartial.
Wh a t d oes u n bia s ed m ea n ?
The forward premium is equal to the expected change in the spot rate
Wh a t d oes t h is con d it ion m u s t h old ?
The forward rate is an unbiased estimate of the future spot rate
For wa r d Ma r ket Pa r it y
The forward premium or discount between two currencies will offset the difference in interest
rates between the two currencies
Furward Premtum =
(Foiwaiu Spot) - (Spot)
Spot
I n t er es t Ra t e Pa r it y
Suppose that your professor has an extra cash reserve of $100,000 to invest for six months.
The six month interest rate is 8 percent per annum n the United States and 7 percent per
annum in Germany. Currently, the spot exchange rate is 1.01 per dollar and the six-month
forward exchange rate is 0.99 per dollar. Your professor does not wish to bear any exchange
risk. Where should he invest to maximize the return?
On You r Own Now - Ba by St ep s
I f I n ves t I n USA
$1uu,uuu _1 +
8%
2
] = $1u4,uuu
I f I n ves t I n GERMANY
They dont take USD
1 -- Buy EUR
1u,uuu 1.u1
E0R
0SB
= 1u1,uuu
2 -- Deposit into bank at 7% annual
1u1,uuu _1 +
7%
2
] = 1u4,SSS
3 -- Use forward to buy USD
1u4,SSS E0R u.99
E0R
0SB
= 1uS,S91 0SB
Because its not annual
but for 6 months
Class 3
Parity Conditions
[Prezi]
Wednesday,February01,2012
Finance Page 1
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Interest USD = 0.25%
Interest EUR = 1.00%
Spot (EUR per 1 USD) = 0.7639 [$1.3091]
Fwd 360 days = 0.7620 [$1.3124]
Fin d For wa r d Pr em iu m s
(u.762u) - (u.76S9)
u.76S9
= (-u.uu248) = -u.248%
(1.S124) -(1.Su91)
1.Su91
= (u.uu2S2 ) = u.2S2%
Bor r ow
100,000 USD @ 0.25%
Will have to pay back -> 100,250
Bu y
EUR @ 0.7639
1uu,uuu u.76S9 = 76,S9u E0R
Dep os it
76,S9u E0R (1 + 1%) = 77,1SS.9u E0R
Bu y Ba ck
USD @ 0.7620
77,1SS.9u u.762u = 1u1,2S1.84 0SB
Pa y Ba ck
1u1,1S1.84 -1uu,2Su = $1,uu2 0SB
Now Let s Tr y A Rea lis t ic On e
Finance Page 2