CFA CFA Level 2 The International Parity Relationship Combined

The International Parity Relationship Combined

  • This topic has 3 replies, 3 voices, and was last updated Apr-17 by vincentt.
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    • Sarah
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      I just don’t seem to understand what this chart is suppose to be telling me.

      This what I understand so far:
      The uncovered interest rate parity is the expectation of the exchange rate movement. We can’t trade on expectations so there is no market to exploit your correct expectations.

      The International Fisher Effect says that the difference in exchange rate is due to interest rate differentials.

      The covered interest parity is held in place by arbitrage as you can go into the forward/future market and profit on difference.

      Why is there an arrow pointing to Exchange rate/Expectations/Movement and Forward Discount or Premium and says that it is a forward rate unbiased predictor?

    • Zee Tan
      Keymaster
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      Given the different relationships that yield a forward discount or premium, that is the unbiased predictor (i.e. best known unbiased estimate) of future spot rates?

    • Sarah
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      @Zee I’ll think about it. But how is our expectations unbiased? Considering we can’t trade on it?

    • vincentt
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      @diya based on what i understand, unbiased predictor of future spot rates means ignoring any other factors that could affect the future currency, the future rate should be exactly like the model you used to calculate it.

      E.g. S * (1+infla_A) / (1 + inflat_B) or S * (1+R_A) / (1 + R_B), etc.

      So, if based on your calculation and your future rate is say (USD/GBP) is 1.55 and the spot rate (when you got to the future) is 1.50.

      USD is overvalued or GBP is undervalued and based on the assumption of the unbiased predictor the rate will move towards 1.55 eventually.

      Correct me if i’m wrong!

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