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Study Session 4: Economics for Valuation

Module 11.2: Mark to Market Value, and Parity Conditions Quiz

Hi,

Please clarify why the expected exchange rate in 1 year = current spot rate x (.99) in the answer to this question:

If the relative form of the PPP holds, the expected exchange rate in one year is closest to:

A) $1.3378 per €.

B) $0.7463 per €.

C) $1.3647 per €.

ANSWER:

A) $1.3378 per €.

Since inflation in Europe is higher than the inflation in the U.S. by 1%, the Euro is expected to depreciate by 1% annually against the dollar.

The current spot rate is $(1/0.74) per Euro or $1.3513/€

Question on converting Currency

Hi all,

I am studying level II and I have encountered the cross rate section and I don’t under stand why we need to do that

For example, If the spread of USD/EUR= 1.1503 - 1.1507

If we want to get the Bid for EUR/USD, we need to use 1 divided by the Ask(Offer) rate of USD/EUR $1.1507.

I don’t under why it is not 1 divided by the bid rate of USD/EUR which is $1.1503 ?

Triangular arbitrage

Simple question on Triangular arbitrage:

If I have currencies A,B,C. 

How do I know I have to set the triangle as, suppose: A-B-C-A and not A-C-B-A? Because it gives a loss/profit, so I might get the question wrong if the question asks “is there a profit of X or loss of Y” 

Do you get my point? 

Cheers!

Economics: Uncovered rate parity doubt.

Hi all. 

According to uncovered rate parity the higher interest rate currency should depreciate in relation to lower interest rate currency. 

To me this makes no sense. 

If USD is 3% and RUB is 8% then shouldn’t I start buying RUB and selling USD? So the FX should go the other way around! 

14.5 Retained earnings vanishing during an acquisition

In the first pic, you see retained earnings for the acquirer (12K) and the target company (4K)

https://ibb.co/MMB5Tmz

The acquirer pays 8,000 to get an 80% interest in the target company. So retained earning should sum up, at least partially, right? How come the retained earnings on the new balance sheet is still only $12K?

https://ibb.co/d4QjrKD

13.a SROs (CFAI)

If a Self-Regulating Organization is a non-government agency that unites, represents, and monitors its members, does that mean the CFA Institute is an SRO?

12a: Preconditions for economic growth and China as an example

  1. The political stability, rule of law, and property rights environment of a country also influence economic growth. Countries that have not developed a system of property rights for both physical and intellectual property will have difficulty attracting capital. Similarly, economic uncertainty caused by wars, corruption, and other disruptions poses unacceptable risk to many investors, reducing potential economic growth.

I think about my trips to China. Not that the U.S. is perfect, but consider the following:

11.k Mundell Fleming and capital mobility

High Capital Mobility

Expansionary monetary policy and expansionary fiscal policy are likely to have opposite effects on exchange rates. Expansionary monetary policy will reduce the interest rate and, consequently, reduce the inflow of capital investment in physical and financial assets.

If interest rates go down, then it becomes cheaper to borrow money, which encourages more investing. Why would the book state that inflow of capital investment is reduced?

11.j Balance of Payments - impact to currency during trade deficits

Flow supply/demand mechanism. Current account deficits in a country increase the supply of that currency in the markets (as exporters to that country convert their revenues into their own local currency). This puts downward pressure on the exchange value of that currency.

I’m not sure I understand what they’re trying to say literally, nor the strategic takeaway. So let’s take USA vs China which has a trade deficit on the U.S. side. Is the book saying that:

1. Chinese manufacturers produce goods that sell in the USA for U.S. dollars, not Chinese Yuan.

Uncovered interest rate parity

For UIP, the expected change in future spot rate = interest country A - country B, therefore, if interest rate country A is greater than B, we would expect to see currency A depreciate against B.

However, I believe that if interest rate in country A is greater than B, we should expect capital inflow to A and outflow from B leading to appreciation  of currency A.

Why does UIP yield different outcome to capital flow perspective?