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questions :interest rate parity
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[Visitor (58.214.*.*)]answers [Chinese ]Time :2022-12-04
The theory of forward exchange rate determination proposed by Keynes and Einzig.
They believe that equilibrium exchange rates are formed through foreign exchange transactions caused by international sell-off arbitrage.
In the event of a difference in interest rates between the two countries, money will flow from countries with low interest rates to countries with high interest rates to make profits.
However, when arbitrageurs compare the rate of return of financial assets, they not only consider the rate of return provided by the interest rates of the two assets, but also consider the change in the income of the two assets due to exchange rate changes, that is, foreign exchange risk.
Arbitrageurs often combine arbitrage with swap business to avoid exchange rate risk and ensure no risk of loss.
As a result of a large number of swap foreign exchange transactions, the spot exchange rate of the currencies of countries with low interest rates rises, and the exchange rate of futures rises;
The spot exchange rate of the currencies of countries with high interest rates rises, and the exchange rate of futures falls.
The forward spread is the difference between the exchange rate and the spot exchange rate, so that there will be a forward premium for the currencies of low-interest countries, and forward discounts for the currencies of high-interest countries.
As the sell-off arbitrage continues, the forward spread will continue to increase until the two assets provide exactly the same rate of return, at which point the sell-off arbitrage activity will stop, and the forward spread will be exactly equal to the spread between the two countries, that is, the interest rate parity is established.
Therefore, we can summarize the basic points of interest rate evaluation:
The forward spread is determined by the interest rate difference between the two countries, and the currency of the country with high interest rate must be discounted in the futures exchange market, and the currency of the country with low interest rate must be premiumized in the futures exchange market.
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