FCRP Question

in the context of Econ: {(F-S)/S}-(Interest FC- Interest DC) in the context of PM: {(F-S)/S}-(Interest DC- Interest FC) Is this correct? Can someone please explain why or why not? Thanks

make sure they are expressed in the same direct/indirect quote schweser is stupid enough to use dc/fc for interest rate parity and fc/dc for all the rest good way to screw you up.

i think the quote is FC/DC in the first one and DC/FC in the second one… or vice versa… but Im willing to bet that the way the currency is quoted is the reason.

I’ll give my 2 cents, but I hate this stuff more than anything else in the curriculum. In econ its given in FC/DC, while in PM its given in DC/FC, where FC and DC mean the way foreign exchange is quoted where FC= foreign currency per 1 domestic currency and DC means domestic currency per unit of foreign currency.

so basically make sure you have the same currency on numerator and denominator on both sides of the equation?

yes

can some one explain this to me then: question says JPY/USD is @ 120 right now and it is expected to fall by 2%…here is the answere (Schweser B6 E1 Q40): Wilsmith¡¯s expected future spot rate [E(S1)] is 2% below the current spot (120 ¡Á 0.98 = 117.6), so the JPY is expected to appreciate by approximately 2% (it takes less JPY to buy 1 USD). You can confirm that by converting the quotes to USD/JPY and calculating the percent change: The USD is the DC and the JPY is the FC. Hence, the FCRP is: FCRP = 2% ¨C (7% ¨C 3.88%) = ¨C1.12% = %¦¤JPY ¨C (rUSD ¨C rJPY) = %¦¤FC ¨C (rDC ¨C rFC) JPY/USD is FC/DC but then the interest rate diff. is being calculated DC-FC?!! what gives?

Ok here is an example… IF interest rates in America are 4% and Interest Rates in UK are 2 %–>The current exchange rate is 2 dollars to a pound. IF you are the investor in America then you are trying to calculate the extra risk premium on the currency (That is you are trying to calculate what you are getting compensated by not hedging your position) SO according to PPP (using inflation to predict EXPECTED spot rate) you get that the exchange rate in a year is 2.04/1–> Meaning the UK pound appreciated 2 %. Since you are an American investor and the its a direct quote (Domestic Currency/ Foreign Currency) You will take 2.04-2/2- (Interest DC of 4% - Interest FC of 2%). So your FCRP is 0. This means that you unhedged position offers no risk compensation AKA it makes sense to hedge your postiion since you are not getting compensated for uncertainty. NOW if the quote is the other way FC/DC this means that you are taking an indirect approach and the dollar will depreciate from .5 to roughly .49 you will then simply see if the extra appreciation of the FOREIGN currency is worth you investing in this investment and how much risk premium it offers. SO you will take the FC/DC- (Interest FC- Interest DC). This way .49-.5/.5 - (2-4) = 0 You see no matter which method you use you will get the same risk premium…you just have to make sure you are using the proper quote (direct in example 1 vs. indirect in example 2). This is also a good check and balance IF you have extra time. Good luck