UK rates are 5% and US rates are 3%. Which currency appreciates/depreciates and by how much? I was discussing this with someone yesterday and I believe US appreciates 2% but they hold the opposite opinion. Which one is correct?
u r correct. Given the rates US should appreciate by ( hold your breath !) (1+uk)^t/(1+us)^t for a time period t . This is also called PPP ( purchasing power parity)
Yeah, this concept trips me off. If rates are higher in UK, wouldn’t investors would rush to invest in that market increasing demand for UK punds? Obviously because of IRP, the forward premium/discount on the exchange rate will reflect the current rate difference so you dont have a arbitrage profit. janakisri, doesnt PPP formula involve Price/inflation levels and exchange rates?
I agree with yodhava. With the information provided, it would seem that UK would appreciate more.
IRP says US dollar SHOULD appreciate by 2%. Remember, higher rates also raise borrowing costs so this is bad for the currency.
bpdulog Wrote: ------------------------------------------------------- > UK rates are 5% and US rates are 3%. > > Which currency appreciates/depreciates and by how > much? > > I was discussing this with someone yesterday and I > believe US appreciates 2% but they hold the > opposite opinion. Which one is correct? and this friend of yours is a level 3 candidate?
excuse me thommo is correct , it is IRP not PPP. And no country that was offering a high rate of interest ever saw their fx rates go up . In fact the idea is to try and keep the fx rates as low as possible to boost exports and keep more people employed
Arent there 3/4 theories that explain the exchange rate movement? Some of these theories might give different answers for the same set of info. And then throw in IRP in the mix. which one would you use? 1. PPP (long term forecast) 2. Portfolio investments (country where rates are higher, portfolio investments will flow there) 3. Foreign Direct Investments (country where rates low, expansionary policies for growth, foreign investments will flow there) 4. Savings/Investments
High inflation rates are implicitly embedded in high interest rates. Economic theory says that real interest rate is equal all over the world. Therefore high interest rates simply mean inflation rates are high and currencies should therefore depreciate. High interest rates will only lead to currency appreciation if inflation rate is low and the central bank is simply using high interest rates to manage the economy.
Me. tega has got it perfect. - The higher real interest rate = appreciating currency - Higher inflation rate = depreciating currency Thats why when banks raise interest rates… real rate increases and inflation normally declines which leads to a stronger currency. Thats how I try and think of it.
From the perspective of someone who works on a forex trading floor, let me just say that this whole currency stuff in the curriculum is weird. For one it’s all quoted the wrong way around (at least to someone who is used to working with market convention). Secondly, hardly any of these theories (PPP, IRP…) hold in practice. It just kills me…I keep having to remember not only the formulas but also the “correct” notation and of course then I have to figure out which is theory and which is the real life answer…!
The interest rates given are nominal interest rates; which is Real + Inflation. Since there is no difference in real interest rates between two counties, the difference in interest rates is due to the higher inflation in the country with higher nominal interest rate. Given the higher inflation rate, the currency of the country with higher nominal rate is likely to depreciate. In this case, pound will depreciate by approximately 2%.
kingstongal Wrote: ------------------------------------------------------- > From the perspective of someone who works on a > forex trading floor, let me just say that this > whole currency stuff in the curriculum is weird. > For one it’s all quoted the wrong way around (at > least to someone who is used to working with > market convention). Secondly, hardly any of these > theories (PPP, IRP…) hold in practice. It just > kills me…I keep having to remember not only the > formulas but also the “correct” notation and of > course then I have to figure out which is theory > and which is the real life answer…! USD/EUR or EUR:USD pls hehehe this got me