I always mess up which inflation to subtract from which, is there an intuitive way to think through this? Tks
anybody please?
not sure what you are even asking. The formulas I think of for FCRP don’t have inflation.
I meant the interest rate differential my bad
i use Domestic - Foreign (F - S)/S - (iD - iF)
Instead of remembering that formula, you can calculate the price of the forward (you should know this formula). Then the FCRP is (E(S1) - F(0))/ S0 ) or intutively, the expected premium over a risk free return.
agree with manstey. mush easier.
I suppose you know this one, [E(S1)-So]/So ~= rDC - rFC For FCRP, you simply rearrange the linear approximation form of the uncovered IRP, use the LHS - RHS. [E(S1)-So]/So ~= rDC - rFC FCRP = [E(S1)-So]/So - (rDC - rFC); and if (F-So)/So ~= rDC - rFC holds, you replace (rDC - rFC) with (F-So)/So, which gives you the other form of FCRP FCRP = (E(S1) - F)/So AND, let me reiterate: ALL EXCHANGE RATES MUST BE EXPRESSED IN DC/FC FORMAT TO MAKE THE ABOVE EQUATIONS WORK.