1、Chapter 6Exchange Rates, Interest Rates, and Interest Rate ParityChapter 6Exchange Rates, InterTopics to be CoveredInterest Rate Parity: Exchange rate, Interest rateFisher Equation: Exchange Rates, Interest Rates, and InflationExpected Exchange Rate and the Term Structure of Interest RateTopics to b

2、e CoveredInterest RNews from the EconomistHot and botheredDespite strict capital controls, China is being flooded by the biggest wave of speculative capital ever to hit an emerging economy. Jun 26th 2008 |BEIJINGNews from the EconomistHot andIn 2007-2008, interest rates in China and the United State

3、s 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 Peoples Bank of China raised its benchmark one-year interest rate on deposits from 2.52% to 4.14%. In 2007-2008, in

4、terest rates iIn 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 R

5、MB has appreciated in value by 21.6%. Most analysts expect the Chinese government to continue the RMBs appreciation.In addition to the attraction Covered Interest Rate Arbitrage Consider the following set of foreign and domestic interest rates and spot and forward exchange rates.Covered Interest Rat

6、e ArbitragCovered 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

7、 800 at i = 10% for one year to achieve 880. Translate 880 back into dollars at F360($/) = $1.30/, the 880 will be exactly $1,144. So What would happen if everyone recognize the arbitrage opportunity?Covered Interest Rate Arbitrag More and more people would exchange $ to at the spot market, so the s

8、pot exchange rate of Pound would appreciate. At the same time, More and more people would exchange to $ at the forward 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 Poun

9、d market, then i$ would increase and i would decrease respectively. More and more people would 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. In practice, in the short Interest Rate ParityThe interest rate parity

10、relationship is a result of profit-seeking arbitrage activity called covered interest rate arbitrage (無風險套利、抵補套利).A U.S. investor deciding between investing in the U.S. or in the U.K. must consider:The interest rates, i$ and iThe spot exchange rate, E , (in $/ )The forward exchange rate, F, (in $/ )

11、Interest Rate ParityThe intereInterest 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

12、over the future dollar value of the investment with a forward exchange contract.Interest Rate Parity (cont.)ByCovered Return（抵補收益）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

13、 is equal to (1 + i)F/E dollars. Arbitrage between the two investment opportunities results in:（6.1）Covered Return（抵補收益）Covered reInterest 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

14、approximated by the equation: （6.3）Interest Rate Parity Interest 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）Effective Return (有效收益) The efReasons Why

15、 Interest Rate Parity May Not HoldBuying and selling foreign exchange and international securities involve transaction costs.Taxes may differ according to an investors residence.Government controls on financial capital flows may exist.There may be political risks.Reasons Why Interest Rate PariIntere

16、st Rates and InflationNominal Interest Ratethe interest rate actually observed in the market.Real Interest Ratethe nominal interest rate minus or adjusted for inflation.Interest Rates and InflationNoFisher EquationThe relationship between interest rates and inflation is given by the Fisher equation:

17、 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）Fisher EquationThe relationshiTABLE 6.1 Interest Rates and Inflation Rates for Selected Countries, 20071TABLE 6.1 Interest Rates and Exchange Rates, Interest Rates, and I

18、nflationIf the real interest rates are equalized internationally, Interest Rate Parity indicates (Given our U.S. and U.K. investment example):（6.7）Exchange Rates, Interest RatesTerm Structure（期限結構） of Interest RatesFor different investment opportunities and for different maturity dates, the interest

19、 rates vary. Term structure of interest ratesthe pattern of interest rates over different terms of maturity dates.Term Structure（期限結構） of Intere1. Expectation long term interest rate tends to be equal to an average of short term rates expected over the long term holding period.2. Liquidity premium r

20、isk premium（People prefer to lend short term）3. Preferred habitat There are different markets for long term and short term interest rate. The interest rates are determined by supply and demand in each market.1. Expectation long term int國際金融(雙語)chap6課件Expected Exchange Rates and Term Structure of Int

21、erest RatesRefer to Figure 6.1 Eurocurrency Interest RatesIf the term structure lines for two countries are:Parallel, then the future changes in exchange rate are expected to be constantDiverging, then the high-interest-rate currency is expected to depreciate at an increasing rate over timeConvergin

22、g, then the high-interest-rate currency is expected to depreciate at a declining rate relative to the low-interest-rate currencyp123Expected Exchange Rates and TeSuppose the term structure of interest rates is rising for the United States and falling for Japan. If this is all you know, what can you

23、say about the expected change in the yen/dollar exchange rate?As we move out over time, the expected change in the exchange rate should increase.Suppose the term structure of ExerciseThe 1-year interest rate on Swiss francs is 5 percent, and the dollar interest rate is 8 percent.a.If the current $/S

24、F spot rate is $0.60, what would you expect the spot rate to be in 1 year?b.Why is there no observable expected future spot rate?c.Suppose U.S. policy changes and leads to an expected future spot rate of $0.63. What would you expect the dollar interest rate to be now? (Assume no change in the Swiss

25、interest rate.)ExerciseThe 1-year interest raa.1.08=1.05+(F-0.60)/0.60, F=0.618b.The reasons of why IRP may not holdc.i$ = (0.63-0.60)/0.60+.05 = 0.10 percenta.1.08=1.05+(F-0.60)/0.60, F=ThoughtIndicate whether the following quotation is true or false, and then carefully explain your answer. “Lender

26、s benefit from unexpected inflation but borrowers are hurt by it.”ThoughtIndicate whether the foSuppose there is no inflation, and I loan you $100 for a year at 5%. But suddenly the money supply zooms, and the inflation rate turns out to be 10% over the year, and on the day you pay me back the $105, it now takes $110 to buy what $100 used to. The $105 wont even be worth what $100 was worth a year ago, and I am clearly worse off for having loaned you the money. Ive receiveda nominal interest rate of 5% but a real intere