Study Session 4, Reading #19- In solving for interest rate using Int’l. Fisher relation, which country’s interest rate would you apply in numerator (and the other country in denominator) when two countries are given, and there is no information about which country is domestic, as in problem #15, page 708? Thanks in advance.
Generally speaking, the domestic rate goes on top.
Hank Moody Wrote: ------------------------------------------------------- > Generally speaking, the domestic rate goes on top. HankMoody, Thanks for responding. Not sure if it goes on top. Per CFAI book (equation 4 in page 679), domestic goes on the bottom? As to my original question as how to identify which country is domestic - I think how you decipher which country is domestic is based on the rate quote. If rate quote is USD:EUR=1.4, it means the quote is for USD, so U.S. interest rate is domestic that goes on the bottom.
Match numerator to numerator, denominator to denominator.
if you have a quote like USD:EUR (or EUR/USD), then US interest rate goes to the denominator and the Eur to the numerator.
For the International Fisher Relation, and indeed, for all of the parity relations: -Measurement currency (for interest rate/inflation rate) goes in the numerator -Quoted currency (for interest rate/inflation rate) goes in the denominator This way, given a quote, determine the quoted currency, the measurement currency and then plug and chug. No need to determine which is domestic and which is foreign. As has been pointed out in another thread, one could be working with currencies for which they are neither the domestic nor the foreign agent! Given the spot rate (GBP:SFR) = 3 in #15, GBP is the quoted currency and SFR the measurement currency. Therefore: IFR:1.04/1.1 = (1+r)/(1.12), where r=one-year interest rate in Switzerland. Therefore, r=(1.12*1.04/1.1)-1 = 5.89% (International Fisher Relation) UIRP: S1/3=(1.0589/1.12), where S1=expected GBP:SFR rate in one year. Therefore S1=2.8364 (Uncovered Interest Rate Parity) IRP: F=3x(1.0589/1.12) = 2.8364 (Interest Rate Parity)