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Finance 5 Pages

Exchange Rate Theoretical Analysis

Question

Paper on theoretical analysis of Exchange Rate

Solution

Title: Exchange Rate Theoretical Analysis
Length: 5 pages (1375 Words)
Style: APA

Preview

Exchange Rate Theoretical Analysis

Interest Rate Parity

The theory focuses on the equilibrium being represented by the no-arbitrage state in which the investors are indifferent to the levels of interest offered by banks in two nations. Given that this condition hardly occurs, it opens up an opportunity to make riskless profits from secured interest arbitrage. The theory has two important assumptions. One of the key assumptions is the capital mobility, as well as perfect substitutability of assets in the foreign and home nation. If the overseas market equilibrium holds, the interest rate parity assumptions imply that returns expected for local investment will be equal to those overseas investments after adjustments of exchange rates. Two distinct forms of interest parity exist with the main difference being that one model pre-empts the risk associated with exchange rate changes. The uncovered interest rate parity is a state where exposure to risks associated with the exchange rate is uninhibited. On the contrary, covered interest rate parity refer to parity situation where organizations or parties enter into forward contract to eliminate the risk of potential changes in the exchange rates         

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