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,Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,5-,*,宁波工程学院国商教研室蒋力编,Chapter,6,Exchange Rates,Interest Rates,and Interest,Rate,Parity,Topics to be Covered,Interest Rate Parity,:Exchange rate,Interest rate,Fisher Equation,:,Exchange Rates,Interest Rates,and Inflation,Expected Exchange Rate and the Term Structure of Interest Rate,News from the Economist,Hot and bothered,Despite strict capital controls,China is being flooded by the biggest wave of speculative capital ever to hit an emerging economy.,Jun 26th 2008|,BEIJING,In 2007-2008,interest rates in China and the United States have been moving in opposite directions.The U.S.Federal Reserve lowered the federal funds rate nine times from a high of 5.25%in June 2007 to 2.00%.Over the same time period,the People,s Bank of China raised its benchmark one-year interest rate on deposits from 2.52%to 4.14%.,In addition to the attraction of the interest rate difference,speculators are moving,“,hot money,”,into China because of the general expectation that the RMB will continue appreciate in value against the U.S.dollar and other currencies.Since July 21,2005,through July 15,2008,the RMB has appreciated in value by 21.6%.Most analysts expect the Chinese government to continue the RMB,s appreciation.,Covered Interest,Rate,Arbitrage,Consider the following set of foreign and domestic interest rates and spot and forward exchange rates.,Spot exchange rate,S,($/),=,$1.25,360-day forward rate,F,360,($/),=,$1.30,U.S.discount rate,i,$,=,5%,British discount rate,i,=,10%,Covered Interest,Rate,Arbitrage,A trader with$1,000 to invest could invest in the U.S,in one year his investment will be worth$1,050=$1,000,(1+,i,$,)=$1,000,(1.05),Alternatively,this trader could exchange$1,000 for,800 at the prevailing spot rate,(note that,800=$1,000,$1.25/,)invest,800 at,i,=10%for one year to achieve,880.Translate,880 back into dollars at,F,360,($/,)=$1.30/,the,880 will be exactly$1,144.,So What would happen if everyone recognize the arbitrage opportunity?,More and more people would exchange$to,at the spot market,so the spot exchange rate of Pound would appreciate.At the same time,More and more people would exchange,to$at the f,orward,market,thus the forward exchange rate of Pound would depreciate.,Moreover at the money market,more and more people would borrow money from US dollar market and lend it to the Pound market,then,i,$,would increase and,i,would decrease respectively.,In practice,in the short term,the response of FEM is much faster than that of money market,so we can have the Interest,Rate,Parity.,Interes,t,Rate,Parity,The interest,rate,parity relationship is a result of profit-seeking arbitrage activity called,covered interest,rate,arbitrage,(无风险套利、抵补套利),.,A U.S.investor deciding between investing in the U.S.or in the U.K.must consider:,The interest rates,i,$,and i,The spot exchange rate,E,(in$/),The forward exchange rate,F,(in$/),Interest,Rate,Parity(cont.),By investing$1 at home,the U.S.investor can earn 1+i,$,for one period.,Or,since$1=1/E pounds,the U.S.investor can invest in the U.K.and earn(1+i,)/E.,Since future spot rates are unknown,the investor can eliminate the uncertainty over the future dollar value of the investment with a forward exchange contract.,Covered Return,（抵补收益）,Covered return,is the domestic currency value of a foreign investment when the foreign currency proceeds are sold in the forward market.,In our example,the covered return is equal to(1+i,)F/E dollars.Arbitrage between the two investment opportunities results in:,（6,.1,）,Interest Rate Parity,Interest rate parity,states that the forward premium(or discount)is equal to the interest,rate,differential,between two currencies,.This parity is approximated by the equation:,（6,.3,）,Effective Return(,有效收益,),The,effective return on a foreign investment,is given by the interest rate plus the expected change in the exchange rate.,Using our example,the effective return is:,（6,.4,）,Reasons Why Interest Rate Parity May Not Hold,Buying and selling foreign exchange and international securities involve transaction costs.,Taxes may differ according to an investor,s residence.,Government controls on financial capital flows may exist.,There may be political risks.,Interest Rates and Inflation,Nominal Interest Rate,the interest rate actually observed in the market.,Real Interest Rate,the nominal interest rate minus or adjusted for inflation.,Fisher Equation,The relationship between interest rates and inflation is given by the,Fisher equation,:,where i is the nominal interest rate,r is the real interest rate,and,is the expected rate of inflation.,Refer to Table,6,.1,（,5.5,）,TABLE,6,.1 Interest Rates and Inflation Rates for Selected Countries,2007,1,Exchange Rates,Interest Rates,and Inflation,If the real interest rates are equalized internationally,Interest Rate Parity indicates(Given our U.S.and U.K.investment example):,（6,.7,）,Term Structure,（期限结构）,of Interest
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