Intrest rate Parity

Jun 28th, 2015
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Aberystwyth University
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Teachers in a school in Basel, Switzerland get paid vacation to do AOL course. • Sudarshan Kriya has been acknowledged by All India Institute of Medical Sciences based on its medical research

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INTREST RATEPARITYIRP The IRP theory states that equilibrium isachieved when the forward rate differential isapproximately equal to the interest ratedifferential. It thus helps determine forward exchangerate.Covered Interest Arbitrage Covere Intrest Arbitrage involves borrowingand lending in two market and also buyingspot and selling forward the respectivecurrency so as to attain benefit or parityconditon.Q. Assume there are 2 markets India and USIn IndiaSpot market-Rs/$ 403m forward Rs/$ 40.28Interest rate- 18% In United States Interest Rate-12%Borrow $ 1000 and 12%Converting $ in Rs as per spot price Rs 40,000Invest 40,000 and 18%Selling the Rs 3m forward at Rs 40.28After 3 m months we would be getting 41,800Selling Rs 41,800 for the rate of Rs/$ 40.28 = $ 1038Repaying the loan in US $ 1030Profit= $ 1038-$ 1030= $ 8But this arbitrage opportunity wouldnot exist for long time- 1) Borrowing in the USA will raise the interest ratethere. Investing in India would increase funds which wouldlead to lower the interest rate Buying Rs at spot rate will increase spot rate of the Rs, Selling Rs forward will depress the forward rate of Rs.Uncovered Interest Arbitrage UIA does not involve forward markettransactions as interest rate differential leadsto change in future spot price.

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