- The law of one price: Pd = Sd/f * Pf
- Absolute PPP: Sd/f = Pd / Pf
- overvalue/undervalue: (Actual exchange rate - Implied exchange rate) / Implied exchange rate
- Relative PPP: S1 = S0 * [ ( P1d / P0d ) / ( P1f / P0f ) ]
The relationship of Forward rate and Interest rate
- ( 1 + id ) = ( 1 + if ) * Fd/f / Sd/f
- id - if ~= ( Fd/f - Sd/f ) / Sd/f
Covered Interest Arbitrage
id - if > ( Fd/f - Sd/f ) / Sd/f
Move funds from f to d
Uncovered Interest Arbitrage
E [ Ptd/f ] = Fd/f
- > buy foreign currency forward
- < sell foreign currency forward
- id - if ~= ( E [ Ptd/f ] - Sd/f ) / Sd/f
- id - if +~= ( E [ Ptd/f ] - Sd/f ) / Sd/f + rp
Real Interests Rates and Real Interest Parity
The Fisher Equation
- ( 1 + i ) = ( 1+ r )( 1 + pi )
- i ~= r + pi
The International Fisher Equation
- ( 1 + id ) / ( 1 + if ) = [ (1 + rd) (1 + E[ pid ]) ] / [ (1 + rf) (1 + E[ pid ]) ]
- ( 1 + id ) / ( 1 + if ) = (1 + E[ pid ]) / (1 + E[ pid ])
