Exchange Rate Intervention and Controls
A country’s capital flows can be advantageous if they increase domestic investment. It is worth noting that an increase in domestic investment leads to economic growth and subsequent currency appreciation, thereby attracting global investors. Even then, capital inflows should not…
Future Exchange Rates and Parity Conditions
Uncovered Interest Rate Parity It states that the change in spot rate over the investment period should be averagely equal to the difference between the interest rates in two different countries. Put another way, the expected appreciation or depreciation should…
The Relationship among International Parity Conditions
In the short run, most international parity conditions do not hold. However, over longer periods, they enjoy significant interaction among themselves courtesy of the interrelationship between interest rates, inflation rates, and exchange rates. Most notably: According to the ex-ante version…
Balance of Payments and Foreign Exchange
The balance of payments (BOP) is used to track transactions between a country and its international trading partners. It can be viewed as an accounting statement that captures all payments made to foreigners and liabilities incurred by them. BOP also…
The Carry Trade
The uncovered interest rate parity suggests that with time, high-yielding currencies will depreciate while the low-yielding ones will appreciate. That is, if the uncovered interest rate parity holds consistently, an investor will earn a profit by taking a long position…
Assessing the Long-run Fair Values of an Exchange Rate
Parity conditions are useful in the assessment of the fair value of currencies. Even then, it is worth clarifying that they cannot be used to gauge the currency value in real time. As discussed previously, parity conditions include the covered…
The Monetary and Fiscal Policies and Determination of Exchange Rates
Government policies have an impact on exchange rate fluctuations. These channels include: 1. The Mundell-Fleming Model This model stipulates that changes in monetary and fiscal policies within a country interfere with interest rates and economic activities. These interferences manifest themselves…
The Triangular Arbitrage Opportunity
Every bid-offer quote a dealer displays in the interbank FX market should possess the following properties to avoid the creation of arbitrage opportunity: The bid should not be higher than the current interbank offer, and the offer should not be…
International Parity Conditions
International parity conditions refer to the economic theories that link exchange rates, price levels (inflation), and interest rates. These theories describe the interrelationships that help determine long-run fluctuations in exchange rates, interest rates, and inflation. Assumptions of International Parity Conditions…
The Mark-to-Market Value of a Forward Contract
A forward contract is an agreement between two parties to trade one currency for another on a specified future date and at a pre-determined rate. In other words, it is an exchange rate transaction whose settlement timeline exceeds T+2. The…
