1、Multinational Financial Management Alan Shapiro7th Edition J.Wiley & SonsPower Points byJoseph F. Greco, Ph.D.California State University, Fullerton1CHAPTER 4PARITY CONDITIONS AND CURRENCY FORECASTING2CHAPTER OVERVIEWI.ARBITRAGE AND THE LAW OFONE PRICEII.PURCHASING POWER PARITYIII.THE FISHER EFF

2、ECTIV.THE INTERNATIONAL FISHER EFFECTV.INTEREST RATE PARITY THEORYVI.THE RELATIONSHIP BETWEEN THE FORWARD AND FUTURE SPOT RATEVII. CURRENCY FORECASTING3PART I. ARBITRAGE AND THE LAW OF ONE PRICEI.THE LAW OF ONE PRICEA. Law states:Identical goods sell for the same price worldwide.4ARBITRAGE AND THE L

3、AW OF ONE PRICEB.Theoretical basis:If the price after exchange-rate adjustment were not equal, arbitrage in the goods worldwide ensures eventually it will.5ARBITRAGE AND THE LAW OF ONE PRICEC.Five Parity Conditions Result From These Arbitrage Activities1.Purchasing Power Parity (PPP)2.The Fisher Eff

4、ect (FE)3.The International Fisher Effect(IFE)4.Interest Rate Parity (IRP)5.Unbiased Forward Rate (UFR) 6ARBITRAGE AND THE LAW OF ONE PRICED.Five Parity Conditions Linked by1.The adjustment of variousrates and prices to inflation.7ARBITRAGE AND THE LAW OF ONE PRICE2.The notion that money should have

5、 no effect on real variables (since they have been adjusted for price changes).8ARBITRAGE AND THE LAW OF ONE PRICEE.Inflation and home currency depreciation:1.jointly determined by the growth of domestic money supply;2.Relative to the growth ofdomestic money demand.9ARBITRAGE AND THE LAW OF ONE PRIC

6、EF. THE LAW OF ONE PRICE- enforced by international arbitrage.10PART II. PURCHASING POWER PARITYI.THE THEORY OF PURCHASINGPOWER PARITY: states that spot exchange rates between currencies will change to the differential in inflation rates between countries.11PURCHASING POWER PARITYII.ABSOLUTE PURCHAS

7、ING POWER PARITYA. Price levels adjusted for exchange rates should beequal between countries12PURCHASING POWER PARITYII.ABSOLUTE PURCHASING POWER PARITYB. One unit of currency has same purchasing power globally.13PURCHASING POWER PARITYIII.RELATIVE PURCHASING POWER PARITYA. states that the exchange

8、rate of one currency against another will adjust to reflect changes in the price levels of the two countries.14PURCHASING POWER PARITY1.In mathematical terms:where et = future spot rate e0= spot rate ih= home inflation if = foreign inflation t= the time periodtfthtiiee11015PURCHASING POWER PARITY2.I

9、f purchasing power parity is expected to hold, then the bestprediction for the one-periodspot rate should betfthtiiee11016PURCHASING POWER PARITY3. A more simplified but less precise relationship isthat is, the percentage change should be approximately equal to the inflation rate differential.fhtiie

10、e017PURCHASING POWER PARITY4.PPP says the currency with the higher inflation rate is expected to depreciate relative to the currency with the lower rate of inflation.18PURCHASING POWER PARITYB.Real Exchange Rates:the quoted or nominal rate adjusted for a countrys inflation rate isthtfttiiee)1()1(19P

11、URCHASING POWER PARITYC.Real exchange rates1. If exchange rates adjust to inflation differential, PPP states that real exchange rates stay the same.20PURCHASING POWER PARITYC.Real exchange rates 2.Competitive positions:domestic and foreign firmsare unaffected.21PART III.THE FISHER EFFECT (FE)I.THE F

12、ISHER EFFECTstates that nominal interest rates (r) are a function of the real interest rate (a) and a premium (i) for inflation expectations. R = a + i22THE FISHER EFFECTB.Real Rates of Interest1. Should tend toward equality everywhere through arbitrage.2. With no government interference nominal rat

13、es vary by inflation differential orrh - rf = ih - if23THE FISHER EFFECTC.According to the Fisher Effect,countries with higher inflation rates have higher interest rates.24THE FISHER EFFECTD.Due to capital market integration globally, interest rate differentials are eroding.25PART IV. THE INTERNATIO

14、NAL FISHER EFFECT (IFE)I.IFE STATES:A. the spot rate adjusts to the interest rate differential between two countries.26THE INTERNATIONAL FISHER EFFECTIFE = PPP + FEtfthtrree)1()1(027THE INTERNATIONAL FISHER EFFECTB.Fisher postulated1. The nominal interest rate differential should reflect the inflati

15、on rate differential.28THE INTERNATIONAL FISHER EFFECTB.Fisher postulated2.Expected rates of return are equal in the absence of government intervention.29THE INTERNATIONAL FISHER EFFECTC. Simplified IFE equation:(if rf is relatively small)100hfeerre30THE INTERNATIONAL FISHER EFFECTD. Implications of

16、 IFE1.Currency with the lower interest rate expected to appreciate relative to onewith a higher rate.31THE INTERNATIONAL FISHER EFFECTD. Implications of IFE2.Financial market arbitrage:insures interest rate differential is an unbiased predictor of change in future spot rate. 32PART VI. INTEREST RATE

17、 PARITY THEORYI.INTRODUCTIONA. The Theory states:the forward rate (F) differs from the spot rate (S) at equilibrium by an amount equal to the interest differential (rh - rf) between two countries.33INTEREST RATE PARITY THEORY2. The forward premium ordiscount equals the interestrate differential. (F

18、- S)/S = (rh - rf) where rh = the home raterf = the foreign rate34INTEREST RATE PARITY THEORY3.In equilibrium, returns oncurrencies will be the samei. e. No profit will be realizedand interest parity existswhich can be written(1 + rh) = F (1 + rf) S35INTEREST RATE PARITY THEORYB.Covered Interest Arb

19、itrage1. Conditions required:interest rate differential doesnot equal the forward premium or discount.2. Funds will move to a countrywith a more attractive rate.36INTEREST RATE PARITY THEORY3. Market pressures develop:a.As one currency is more demanded spot and sold forward.b. Inflow of fund depress

20、es interest rates.c.Parity eventually reached.37INTEREST RATE PARITY THEORYC.Summary:Interest Rate Parity states:1.Higher interest rates on a currency offset by forwarddiscounts.2.Lower interest rates are offset by forward premiums. 38PART VI. THE RELATIONSHIP BETWEEN THE FORWARD AND THE FUTURE SPOT RATEI.THE UNBIASED FORWARD RATEA. States that if the forward rate is unbiased, then it should reflect the expected future spot rate.B. Stated asft = et39PART VI. CURRENCYFORECASTINGI.FOR