Vol 3. Reading 23 pg. 118 end of chapter questions Q 18. Looking independently at each of the economic observations below, indicate the country where an analyst would expect to see a strengthening currency for each observation. …Canada…UK…Ans. pgA-11 Expected inflation over next year…2.0%…3.0%…Can Real infl adj gov’t 10-yr bond rate…4.8%…5.1%…UK ST (1-month) gov’ rate…1.9%…5.0%…UK Expected GDP growth next yr…2.0%…3.3%…UK I recall reading that lower interest rates can stimulate economic growth and result in an appreciating currency. However here in this example lower real inflation adjusted interest rates are associated with a depreciating currency. Is that inconsistent? Is this a ST v. LT thing? If there were no comparison, say all that was provided in this question was the info for Canada and you are told that the real inflation adjusted gov rate goes from 4.8 to 4.5 would that too imply a depreciating currency?
are you seriously asking people on here to do another cfa question? i would like to slap you across the face if we weren’t in the virtual world.
If I remember correctly, inflation was stable and rate was going down. So the real rate was going down, leads to currency depreciation. Not sure though…
Wow jimmy, you could try that though I am not sure how that would turn out for you. Anyway, I am not asking you to do anything. It is answered for you. The example is included so your lazy ass doesn’t have to open a book. The point of the post is straightforward in that this example was in the text and it is potentially relevant to a topic recently debated. So back off Mr. tough guy, registered Monday 6-8-09.
slouiscar Wrote: ------------------------------------------------------- > Vol 3. Reading 23 pg. 118 end of chapter questions > > > Q 18. Looking independently at each of the > economic observations below, indicate the country > where an analyst would expect to see a > strengthening currency for each observation. > > … > …Canada…UK… > …Ans. pgA-11 > Expected inflation over next > year…2.0%…3.0%. > …Can > Real infl adj gov’t 10-yr bond > rate…4.8%…5.1%… > …UK > ST (1-month) gov’ > rate…1.9%… > …5.0%…UK > Expected GDP growth next > yr…2.0%…3 > .3%…UK > > I recall reading that lower interest rates can > stimulate economic growth and result in an > appreciating currency. However here in this > example lower real inflation adjusted interest > rates are associated with a depreciating currency. > Is that inconsistent? Is this a ST v. LT thing? > If there were no comparison, say all that was > provided in this question was the info for Canada > and you are told that the real inflation adjusted > gov rate goes from 4.8 to 4.5 would that too imply > a depreciating currency? Lower real should lead to a depreciation of currency. Most of the currency stuff assumes that real rates are constant and that lower rates are due to less inflation. It is all that Fischer (sp?) stuff from L2.
Thank you. I think I read that lower interest rates would stimulate economic growth and that would ultimately result in currency appreciation and it got me turned around.
slouiscar Wrote: ------------------------------------------------------- > Thank you. I think I read that lower interest > rates would stimulate economic growth and that > would ultimately result in currency appreciation > and it got me turned around. This is confusing because there were 4 different currency theories presented in the econ material and each was a least partially counter to the other. PPP, capital flows, relative strenght and something else that wasn’t easily applied to forecasting.
there are 2 ways to look at interest rate effects on exchange rates. PPP and capital flow. IRP shows that lower interest rate should lead to currency depreciation. Ppl will move money out of the country because they earn less interest. However, there is a point to where if the interest rate is low enough, it will attract capital flow in because the low interest rate is driving growth, such as in the equity markets. This will cause the currency to appreciate. There is a tipping point where capital flow will takeover. This is all assuming inflation is constant.
LongOnCFA Wrote: ------------------------------------------------------- > there are 2 ways to look at interest rate effects > on exchange rates. PPP and capital flow. IRP shows > that lower interest rate should lead to currency > depreciation. Ppl will move money out of the > country because they earn less interest. However, > there is a point to where if the interest rate is > low enough, it will attract capital flow in > because the low interest rate is driving growth, > such as in the equity markets. This will cause the > currency to appreciate. There is a tipping point > where capital flow will takeover. This is all > assuming inflation is constant. Yes. Currency changes can always be explained by interest changes… Doesnt this exactly prevent interest rates from being the LEAST likely factor?
No, because in the question nominal interest rate went down, while inflation was same. This would imply currency depreciation. So the interest rate is the least likely factor in curency appreciation (it is actually implying an opposite effect of depreciation).
LongOnCFA Wrote: ------------------------------------------------------- > No, because in the question nominal interest rate > went down, while inflation was same. This would > imply currency depreciation. So the interest rate > is the least likely factor in curency appreciation > (it is actually implying an opposite effect of > depreciation). Ok. Forgive me for being so slow. Question1: Please explain to me why it couldn’t sometimes result in more investments and therefore appreciation. You said yourself there was a tipping point. Maybe we are there now? Question2: Lets assume constant inflation of 3.3%. How can this result in appreciation of currency?
The whole trick is related to whether we are talking about REAL interest rates or not. If real interest rates go up (down) it leads to an appreciation (depreciation) of the currency. basta!
akibe Wrote: ------------------------------------------------------- > The whole trick is related to whether we are > talking about REAL interest rates or not. > > If real interest rates go up (down) it leads to an > appreciation (depreciation) of the currency. > > basta! So the capital flows approach doesnt apply when real interest go down?
OK, follow me here: As far as I remember, we should use “all-else-equal”-approach. GDP: If GDP goes up and other factors are equal-> currency appreciates Inflation: If inflation is stable, and all-else-equal -> currency remains constant Interest: If interest down-> normally depreciation, sometimes appreciation (capital flows approach) This could mean that least like is inflation (if all else equal)
I remember this question clearly and was actually the last queston of the test I did since I saved it for the end. I still see it in my head. the inflation rates for both countries were the same at 3.3% The short term interest rates , one country had higher short term rate of 25 bps The question asked based on the table, which of the following would least likely cause currency appreciation. Now the “least likely” cause is debatable on this board, but if it was least likely-appreciation, than the answer would be the inflation rates. No such thing as good inflation ( well for this material of the exam). See you really couldnt choose interest rates because a 25 basis point difference in short term rates between countires is not enough to make a difference as to which country you should invest in or not.
Bacaladitos Wrote: ------------------------------------------------------- > OK, follow me here: > > As far as I remember, we should use > “all-else-equal”-approach. > > GDP: > If GDP goes up and other factors are equal-> > currency appreciates > > Inflation: > If inflation is stable, and all-else-equal -> > currency remains constant > > Interest: > If interest down-> normally depreciation, > sometimes appreciation (capital flows approach) > > > This could mean that least like is inflation (if > all else equal) Because of this I think the question is unclear and I have sent a “comment” to the CFA Institute.
This is what had me rethinking that. Thanks for your input. One last step in my head. Lets say I change it a little and instead ask you this: If inflation is stable, and interest rates are going down, which is least likely to result in —continued— appreciation of a currency? I mean if a currency has been appreciating the past few years w/ inflation at 3% and I expect inflation next year to remain steady at 3%, is stable inflation least likely to result in future appreciation? In contrast, if I expect real interest rates to decline, isn’t that least likely to result in appreciation since declining real tends to depreciate a currency? I have no idea how to parse all those double negatives. My head has it like this: least likely to result in apprec ~ potential to result in deprec. So all else the same, steady inflation = to the infl level during the recent period of currency apprec… that would not potentially result in deprec. real rate declines from level during recent period of currency apprec, that would potentially result in deprec. therefore int rate is least likely to result in —continued— apprec? Of course for econ, I am “least likely” to be correct.
I tried to hold everything constant, and not get into second derivative thinking. Productivity increasing => appreciation stable inflation => no effect interest rate cut = most likely to cause depreciation, so least likely to support appreciation. like all of my other post-exam posts, it’s probably wrong, but I thought I’d throw out my $.02.
^^ agree with that. concise.
ilvino Wrote: ------------------------------------------------------- > I tried to hold everything constant, and not get > into second derivative thinking. Productivity > increasing => appreciation > stable inflation => no effect > interest rate cut = most likely to cause > depreciation, so least likely to support > appreciation. > I understand your thinking here and I hope this isn’t what they seek!! One could state that if inflation is stable-> constant currency->0% chance of appreciation Or One could state that if inflation is stable-> 50% chance of small appreciation Interest cut may be 10 or 20% chance of appreciation…