Interest Rate Parity Essay

Published: 2019-11-23 07:42:19
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Category: Currency

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One can trade for immediate delivery of the currency, when we shall be trading at a spot rate of exchange. Alternatively one can buy or sell the currency under a forward contract. Here delivery will take place on some specified date in the future but the exchange rate at which the transaction is effected is set now. In theory were the nominal interest rates the same, in the countries of currencies, the spot and forward rates would be the same.

Can be summarized in this context as saying that where rates will not be the same. The relationship is as follows;

 1 + rnh = f1

1 + rnf       e0

Where f1 is the future value, in the currency of the home country, of one unit of the foreign currency and the other symbols are as previously specified.

The future rate will be higher than the spot rate where the interest rate in the home country is larger than that in the foreign country. For example, you would have to pay more in that UK interest rates are higher than US ones, you would have to pay more in sterling for US dollars, if you were to take delivery of the dollars you would be able to benefit from the better UK interest rates for longer than if you were to exchange sterling for dollars immediately. The converse would also be true.

Then one should say that the dollar is trading at a forward discount against sterling. Were the opposite state of affairs to apply, sterling would trade at a forward discount against the dollars. The size of the premium or discount depends; of course, partly on how far into the future the exchange will occur.

Therefore interest rate parity hold since it shows how exchange rate of currencies are determined.

f. international arbitrage opportunities  that exist my organization include the performance stock markets. Foreign government bonds which are risk free, blue chip company bonds and direct investment opportunities. This arbitrage opportunities gives explicit prescription about how a  company enters international market.

Most option trading takes place in near-the-money short-term contracts.  Low liquidity in far-from-the-money contracts increases the likely hood that last option trade occurred some time before trading ceased in the stock.  This means that the reported option price needs to reflect the actual price for which an option could be bought or sold when the stock stopped trading at the end of the day.

The company will  purchase (sell) options will probably get the ask (bid) price quoted in the trading stocks.  By looking at the closing price, the investor does not know if the trade took place at the bid, at the ask, or in between. If, for example, the spread is ½ and the closing price is 3, then if the last transaction took place at the bid (aks), the bid-ask spread 3-31/2-3) hence, given a closing price of 3, the bid aks speak creates uncertainly in prices between 21/2 and 31/2. This spreads 33 % of the closing price.

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