Lecture 5 - international financing investmnet & exchange rate movements

key concepts

covered investmnet

uncovered investment

exchange rate movements

types of exchange rate risk

transaction risk

translation risk

how do firm and investors deal with exchange rate risk

speculating

hedging

arbitrage and interest parity

forward rate (f)

expected future spot rate (e^ex)

covered investment (hedging)

uncovered investment (speculating

1 HCU invested in domestic assets yields a return of: (1+i_H)

1 HCU invested in foreign assets yields a return of: (1+i_H)(f/e)

covered interest parity condition

(f-e)/e=i_H-i_F

implications

changes in interest rate will trigger changes in the forward rate

changes in the current spot rate will trigger changes in the forward rate

changes in interest rates will trigger changes in the current spot rate

testing for CIP

interest rate differential should be approximately equal to the forward premium

1 HCU invested in foreign assets yields and expected return of: (1+i_F)(e^ex/e)

uncovered interest parity condition

1 HCU invested in domestic assets yields a return of: (1-i_H)

(e^ex-e)/e=i_H-i_F

implications

changes in interest rates will trigger changes in current spot rate

changes in teh expected future spot rate will trigger changes int he current spot rate

UPI - role of expectations

short run

long run

determinants of prices