Friday, December 03, 2004

Interest Rate Parity Brought Home

One of the final topics studied in most undergraduate finance courses is something called "interest rate parity." The concept is a simple one. It states that investors should earn an equal rate of interest on equal risk investments, regardless of the currency involved. In mathematical form, this means:

Forward Rate/Spot Rate = (1+kh)/(1+kf)

Where the forward rate and the spot rate are in terms of home currency per foreign currency unit, kh is the interest rate at home and kf is the interest rate in the foreign land.

Recently, exchange rates have been changing, with the dollar becoming weaker (less foreign currency is provided per dollar exchanged). To counterbalance this change, the above equation implies that interest rates at home will have to increase, since the change in currency rate is accelerating (the difference between the spot rate and the forward rate is becoming greater).

A related concept is purchase price parity. The classic example of this is the Big Mac. We assume that if a Big Mac costs $10 in the USA, then the same Big Mac must cost the equivalent of $10 in any foreign country into which it is sold. This is summarized by the equation:

Spot Rate = Price at home / Price in Foreign Land

Where the price at home would be in the home currency and the price in the foreign land would be in the foreign currency. Since the cost of a Big Mac in Europe is pretty stable, the fall of the dollar in terms of Euros purchased per Dollar implies the cost of the Big Mac will soon increase by a like amount in the United States.


Anonymous Anonymous said...

Superb, what a weblog it is! This weblog provides useful data to us, keep it up.
Also see my web page :: funnymariogames

December 20, 2012 at 11:46 AM  
Anonymous Anonymous said...

Malaysia & Singapore & brunei greatest on the internet blogshop for wholesale & supply korean accessories, accessories, earstuds, necklace, rings,
bracelet, bangle & hair accessories. Offer 35 % wholesale discount. Ship Worldwide
Also see my web site > Onesies

January 6, 2013 at 1:27 AM  
Anonymous Anonymous said...

Malaysia & Singapore & brunei ideal on the internet blogshop for wholesale
& supply korean add-ons, earrings, earstuds, pendant, rings, bracelet, bangle & hair accessories.
Offer 35 % wholesale markdown. Ship Worldwide
My web site > paku stitch

January 7, 2013 at 8:38 AM  
Anonymous Anonymous said...

Awesome post.
My web site - Family vacation at Upper James Manor

January 26, 2013 at 4:18 PM  
Anonymous Anonymous said...

I love it whenever people come together and share opinions.
Great blog, stick with it!
my webpage - massive systems propagate

January 28, 2013 at 1:41 PM  
Anonymous Anonymous said...

Superb, what a weblog it is! This web site gives helpful facts to us, keep it up.
Also see my web page > website marketing

January 31, 2013 at 2:20 PM  
Anonymous Anonymous said...

WOW juѕt ωhat Ι ωas looκing for.

Came here bу seаrсhing foг halvahѕ

Ϻy web-sіte :: ClickRead
My web site > CarbonPoker Offer

February 26, 2013 at 5:39 AM  
Anonymous Anonymous said...

Нmm is anyone elsе having prоblems wіth the
imageѕ οn this blog loading? I'm trying to determine if its a problem on my end or if it's the blog.
Any suggestions woulԁ bе greatly apргeciateԁ.

Alsο vіsіt my webpage ::
my page - AmericasCardRoom Offer

February 28, 2013 at 8:52 PM  
Anonymous Anonymous said...

Nice replies іn return of this querу with genuine aгgumеntѕ and descrіbing
all regardіng that.

Мy site:

March 9, 2013 at 4:31 AM  
Anonymous Anonymous said...

Тhat is best renown сlothe up gamеs
on thе net. Few іnclude that the happiest uѕers Presently, are the cuddling today yοu get to looκer numerous high schoοl-definіtion, lifetime-liκe games out Τhere.
This ρolitiсаl campaіgn iѕ ωhere ρlayers аrе caρаble to get your dog Plunk
for and lаst retroveгt abode in this mysticаl obѕcure
aim teаser gamble!

Also visit my ωeb blog ... Walmat.altervista.Org

April 11, 2013 at 8:13 PM  
Anonymous Anonymous said...

hey there and thanks on your info ? I have definitely picked up something new from
proper here. I did on the other hand expertise
some technical issues the use of this site,
as I skilled to reload the web site a lot of instances previous to I may
get it to load correctly. I have been puzzling over in
case your web hosting is OK? No longer that I'm complaining, however sluggish loading instances instances will often impact your placement in google and could harm your high-quality ranking if advertising and marketing with Adwords. Anyway I am including this RSS to my e-mail and could glance out for a lot more of your respective intriguing content. Make sure you replace this once more soon..

Review my web page; Online Poker

June 3, 2013 at 6:12 PM  

Post a Comment

<< Home