Suppose you have any spot exchange rate of /E If IR increases in the domestic country () relative to E, according to this formula wouldnt this decrease the value of the domestic country ()...Since the numorator is increasing relative to the dominator (increases exchange rate)... Forward /E = spot /E [(1+ rate)/(1+E rate)] Spot /E = 2 After increase in rate Spot $/E = 3 Does any of this make sense? I thought for an increase of IR in the domestic country relative to the foreign country… Exchange rate of the domestic country should increase
All esle the same, yes. And that is what happened in your example above. exchange rate increased, from the holder’s point of view
I think chadtap mis-typed the third line from bottom. It should be Forward $/E = 3. Direct forward rate will increase if domestic interest rate increases to hold IRP. This means domestic currency is expected to depreciate in the future in return for the increase in its interest rate.
Thanks guys…