1. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall1 Chapter 6: Interest Rate Parity Power Points created by: Joseph F. Greco Ph. D. California State University, Fullerton Mihaylo College of Business and Economics

2. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall2 Chapter 6: Interest Rate Parity 6.1The Theory of Covered Interest Rate Parity 6.2Covered Interest Rate Parity in Practice 6.3Problems Related to Testing Interest Rate Parity 6.4Hedging Transaction Risk in the Money Market 6.5The Term Structure of Forward Premiums and Discounts

3. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall3 6.1The Theory of Covered Interest Rate Parity The Theory of Covered Interest Rate Parity: Overview The Intuition Behind Interest Rate Parity Two Ways to Buy a Currency Forward Why There Must Be Interest Rate Parity Deriving Interest Rate Parity

4. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall4 6.1The Theory of Covered Interest Rate Parity The Intuition Behind Interest Rate Parity Two Ways to Buy a Currency Forward Why There Must Be Interest Rate Parity Deriving Interest Rate Parity

5. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall5 6.1The Theory of Covered Interest Rate Parity Two Ways to Buy a Currency Forward Buy a forward contract

6. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall6 6.1The Theory of Covered Interest Rate Parity Why There Must Be Interest Rate Parity Covered interest rate arbitrage

7. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall7 6.1The Theory of Covered Interest Rate Parity Deriving Interest Rate Parity A general expression for interest rate parity Interest rate parity and forward premiums and discounts

8. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall8 Exhibit 6.1 Diagram of Covered Interest Arbitrage

9. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall9 Exhibit 6.2 Kevin Anthony’s Arbitrage

10. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall10 6.2Covered Interest Rate Parity in Practice The External Currency Market Transaction costs in the external currency market How the external currency market affects other capital markets London interbank offer rate (LIBOR)

11. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall11 Exhibit 6.3 Interest Rates in the External Currency Market

12. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall12 6.2Covered Interest Rate Parity in Practice Covered Interest Arbitrage with Transaction Costs –An empirical test

13. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall13 Exhibit 6.4 Covered Interest Rate Parity with Bid-Ask Rates

14. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall14 Exhibit 6.5 – Panel A $/£ Covered Interest Arbitrage into £

15. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall15 Exhibit 6.5 – Panel B $/£ Covered Interest Arbitrage into £

16. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall16 6.3Problems Related to Testing Interest Rate Parity Default Risks Exchange Controls Political Risk The Thrilla in Manila

17. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall17 Exhibit 6.6 External and Internal FRF Interest Rates and Difference

18. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall18 6.4Hedging Transaction Risk in the Money Market Hedging Transaction Risk - Money Market: Overview Introduction Hedging a Foreign Currency Liability Hedging a Foreign Currency Receivable

19. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall19 6.4Hedging Transaction Risk in the Money Market Introduction Synthetic forward Money market hedge

20. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall20 6.4Hedging Transaction Risk in the Money Market Hedging a Foreign Currency Liability

21. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall21 6.4Hedging Transaction Risk in the Money Market Hedging a Foreign Currency Receivable

22. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall22 6.5 The Term Structure of Forward Premiums and Discounts The Term Structure of Interest Rates –Spot Interest Rates –A Review of Bond Pricing –Yields to Maturity –Deriving Long-Term Spot Interest Rates

23. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall23 6.5 The Term Structure of Forward Premiums and Discounts Long-Term Forward Rates and Premiums