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