Schweser page 277 Example. If interest rate of DC = 7% and interest rate of FC = 3% then shouldn’t DC appreciate by 4%? Why is the foreign currency appreciation by 5% in the example? Thanks!
are you sure about the page #? 277 seems to be in the middle of problems in Financial reporting and analysis.
Schweser Book 3, pg. 277 For reference I asked about this already in the following thread: http://www.analystforum.com/phorums/read.php?12,910184 Anyways, here is swaptiongamma’s response: S0 = 2.00 DC/FC Interpretation of S0 = 1 unit of FC can buy 2 units of DC today E(S1) = 2.1 DC/FC Interpretation of E(S1) = 1 unit of FC will buy 2.1(more) units of DC in the future Conclusion FC appreciated or DC depreciated – whatever you like. Doing the math (straight out of the book): 2.1 - 2.0 / 2.0 = 0.05 It’s the % change, not just the difference.
Approximate IRP states that FC appreciation ~ Interest Rate Differential As per page 277 Interest Rate Differential = rdc - rfc = 7% - 3% = 4% So FC should have ‘ideally’ appreciated by 4%, instead it appreciated by 5%, so the difference is the FCRP = 1%
I think my problem was i forget that the interest rates are nominal interest rates? Since the DC interest rate was higher than FC, that means DC has higher inflation, so yes DC should depreciate/FC appreciate.