International Finance
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1.54285
1.3150%
0.8450%
Suppose the investor has£1,000,000 andthismoney is in the UK, then theprocessof arbitrage opportunity investment in 1 year period can be:
II. CompareEUR/GBP (Date: @00:16:00 on Nov 12th, 2010)
Time
Spot Rate
Forward Rate
UKdiscount rate
EURdiscount rate
6 months
0.8461
0.84041
0.5700%
1.1500%
1 year
Stage 3: Change€1199031to£withthe forward contract F0,360, resulting in€1199031×£0.83877/€=£1005711
If the investor does not invest in the above foreign exchange transaction activities and put money in the UK bank for one year at the rate ofrh= r£= 1.3150% instead, then the investment return is£1,000,000×(1+1.3150%) =£1,013,150.The arbitrage profit is thedifferencebetween the investment returns of foreigncurrency exchange, which is£1005711－£1013150 =－£7439.So there isnoarbitrage opportunity exist in thisactivity.
Stage1:The spot exchange rate S0=$1.6146/£, which is£1,000,000×$1.6146/£=$1614600
Stage 2: Invest this amount of$1614600 in one year in USA at the rate ofrf= r$=0.8450%. At the end of one year, the investment return is$1614600×(1+0.8450%) =$1628243.
Stage1:The spot exchange rate S0=£0.8461/€, whichis £1,000,000/£0.8461/€=€1181893
Stage 2: Invest this amount of€1181893in one year inEurolandatthe rate ofrf= r$=1.4500%. At the end of one year, the investment return is€1181893×(1+1.4500%) =€1199031.
Stage 3: Change$1628243 to£withthe forward contract F0,360, resulting in$1628243/$1.54285/£=£1055348
If the investor does not invest in the above foreign exchange transaction activitiesand put money in the UK bank for one year at the rate ofrh= r£= 1.3150% instead, then the investment return is£1,000,000×(1+1.3150%) =£1,013,150.The arbitrage profit is thedifferencebetween the investment returns of foreigncurrencyexchange, which is£1055348－£1013150 =£42198.So there is arbitrage opportunity exist in thisactivity.
Let us look at a simple example and then use the same principle to test the real data.Suppose the spot rate €/$=1.3883, one year forward exchange rate of €/$=1.3785, Euro discount in one year is 3.5% pa and US dollar discount rate in one year is 2.5% pa, then we can calculate theleft hand sideof the above identity is
Empirical Study of Covered Interest Rate Parity
1.Introduction
Covered Interest rate parity (CIRP) condition states that foreign exchange markets are in equilibrium when expected returns on deposits in a given period in one currency are equal to the expected returns on deposits in another currency when both the returns are measured in terms of a common currency.CIRP is really important since it will bring the opportunity of arbitrage if it does not hold.In most cases, the existence of transaction costs eliminates the arbitrage opportunities. There are lots of studies focused onthe validity ofCIRPand efficiency of the markets to see whether there exists the unexploited profit opportunities.
I. Compare GBP/USD (Date: @02:52:00 on Nov 10th, 2010)
Time
Spot Rate
Forward Rate
UKdiscount rate
USdiscount rate
6 months
1.6146
1.5854
0.5700%
0.5450%
1 year
1.6146
1.3616
1.3546
0.8450%
1.Leabharlann Baidu500%
Suppose the investor has$1,000,000 andthismoney is in the USA, then theprocessof arbitrage opportunity investment in 1 year period can be:
CIRPreflects the relation among the interest rate and spot and forward exchange rates in the following way:
Where is the forward exchange ratecontracted now and to be delivered in the next periodT, is the current spot rate, is the interest rate in the home country during that period and is the interest rate in the foreign country during that period. In some cases, T=1 year, we will have the usual CIRP identity.The other equivalent CIRP identity is defined by the forward premium
III. Compare EUR/USD (Date: @00:02:00 on Nov 12th, 2010)
Time
Spot Rate
Forward Rate
US discount rate
EURdiscount rate
6 months
1.6146
1.35823
0.5450%
1.1500%
1 year
Coursework 1
Paper ID
Module Title: International Finance
Module Code: 26356
Module Leader: Prof.PeijieWang
Student Name:ZhenpingHuang
Student No: 200919627
Stage1:The spot exchange rate S0=$1.3616/€, whichis$1,000,000/$1.3616/€=€734430.1
Stage 2: Invest this amount of€734430.1in one year inEurolandatthe rate ofrf= r$= 1.4500%. At the end of one year, the investment return is€734430.1×(1+1.4500%) =€745079.3
Clearly the CIRP identity does not hold since L.H.S<R.H.S, therefore people canprofit fromthe opportunity of arbitrage.
Now come to investigate the real market data.
2.Analysisand Discussion
In the following of this section, no transaction costs and various transaction costs will both be examined.
a.WithoutTransaction Costs
Tests of covered interest rate parityare prevalent in the economics and finance literature. These studies demonstrate that there doesaresome profitable deviations of exchange rates and interest rates from the equilibrium implied byCIRP.The objective of this report is toexamine several pairs of currencies, and one currency against several currencies with different time horizons.
0.8461
0.83877
1.3150%
1.4500%
Suppose the investor has£1,000,000 andthismoney is in the UK, then theprocessof arbitrage opportunity investment in 1 year period can be:
1.3150%
0.8450%
Suppose the investor has£1,000,000 andthismoney is in the UK, then theprocessof arbitrage opportunity investment in 1 year period can be:
II. CompareEUR/GBP (Date: @00:16:00 on Nov 12th, 2010)
Time
Spot Rate
Forward Rate
UKdiscount rate
EURdiscount rate
6 months
0.8461
0.84041
0.5700%
1.1500%
1 year
Stage 3: Change€1199031to£withthe forward contract F0,360, resulting in€1199031×£0.83877/€=£1005711
If the investor does not invest in the above foreign exchange transaction activities and put money in the UK bank for one year at the rate ofrh= r£= 1.3150% instead, then the investment return is£1,000,000×(1+1.3150%) =£1,013,150.The arbitrage profit is thedifferencebetween the investment returns of foreigncurrency exchange, which is£1005711－£1013150 =－£7439.So there isnoarbitrage opportunity exist in thisactivity.
Stage1:The spot exchange rate S0=$1.6146/£, which is£1,000,000×$1.6146/£=$1614600
Stage 2: Invest this amount of$1614600 in one year in USA at the rate ofrf= r$=0.8450%. At the end of one year, the investment return is$1614600×(1+0.8450%) =$1628243.
Stage1:The spot exchange rate S0=£0.8461/€, whichis £1,000,000/£0.8461/€=€1181893
Stage 2: Invest this amount of€1181893in one year inEurolandatthe rate ofrf= r$=1.4500%. At the end of one year, the investment return is€1181893×(1+1.4500%) =€1199031.
Stage 3: Change$1628243 to£withthe forward contract F0,360, resulting in$1628243/$1.54285/£=£1055348
If the investor does not invest in the above foreign exchange transaction activitiesand put money in the UK bank for one year at the rate ofrh= r£= 1.3150% instead, then the investment return is£1,000,000×(1+1.3150%) =£1,013,150.The arbitrage profit is thedifferencebetween the investment returns of foreigncurrencyexchange, which is£1055348－£1013150 =£42198.So there is arbitrage opportunity exist in thisactivity.
Let us look at a simple example and then use the same principle to test the real data.Suppose the spot rate €/$=1.3883, one year forward exchange rate of €/$=1.3785, Euro discount in one year is 3.5% pa and US dollar discount rate in one year is 2.5% pa, then we can calculate theleft hand sideof the above identity is
Empirical Study of Covered Interest Rate Parity
1.Introduction
Covered Interest rate parity (CIRP) condition states that foreign exchange markets are in equilibrium when expected returns on deposits in a given period in one currency are equal to the expected returns on deposits in another currency when both the returns are measured in terms of a common currency.CIRP is really important since it will bring the opportunity of arbitrage if it does not hold.In most cases, the existence of transaction costs eliminates the arbitrage opportunities. There are lots of studies focused onthe validity ofCIRPand efficiency of the markets to see whether there exists the unexploited profit opportunities.
I. Compare GBP/USD (Date: @02:52:00 on Nov 10th, 2010)
Time
Spot Rate
Forward Rate
UKdiscount rate
USdiscount rate
6 months
1.6146
1.5854
0.5700%
0.5450%
1 year
1.6146
1.3616
1.3546
0.8450%
1.Leabharlann Baidu500%
Suppose the investor has$1,000,000 andthismoney is in the USA, then theprocessof arbitrage opportunity investment in 1 year period can be:
CIRPreflects the relation among the interest rate and spot and forward exchange rates in the following way:
Where is the forward exchange ratecontracted now and to be delivered in the next periodT, is the current spot rate, is the interest rate in the home country during that period and is the interest rate in the foreign country during that period. In some cases, T=1 year, we will have the usual CIRP identity.The other equivalent CIRP identity is defined by the forward premium
III. Compare EUR/USD (Date: @00:02:00 on Nov 12th, 2010)
Time
Spot Rate
Forward Rate
US discount rate
EURdiscount rate
6 months
1.6146
1.35823
0.5450%
1.1500%
1 year
Coursework 1
Paper ID
Module Title: International Finance
Module Code: 26356
Module Leader: Prof.PeijieWang
Student Name:ZhenpingHuang
Student No: 200919627
Stage1:The spot exchange rate S0=$1.3616/€, whichis$1,000,000/$1.3616/€=€734430.1
Stage 2: Invest this amount of€734430.1in one year inEurolandatthe rate ofrf= r$= 1.4500%. At the end of one year, the investment return is€734430.1×(1+1.4500%) =€745079.3
Clearly the CIRP identity does not hold since L.H.S<R.H.S, therefore people canprofit fromthe opportunity of arbitrage.
Now come to investigate the real market data.
2.Analysisand Discussion
In the following of this section, no transaction costs and various transaction costs will both be examined.
a.WithoutTransaction Costs
Tests of covered interest rate parityare prevalent in the economics and finance literature. These studies demonstrate that there doesaresome profitable deviations of exchange rates and interest rates from the equilibrium implied byCIRP.The objective of this report is toexamine several pairs of currencies, and one currency against several currencies with different time horizons.
0.8461
0.83877
1.3150%
1.4500%
Suppose the investor has£1,000,000 andthismoney is in the UK, then theprocessof arbitrage opportunity investment in 1 year period can be: