The below question is taken from Schweser. Please can someone help my understanding? Angle uses a three country example from North America to illustrate foreign exchange parity relations. In it, the Canadian dollar is expected to depreciate relative to the U.S. dollar and the Mexican peso. Nominal, one year interest rates in the U.S. are 7% and are 13% in Mexico. From this data, and using the uncovered interest rate parity relationship, Angle forecasts future spot rates. Using Angle’s analysis, what is the nominal one year interest rate in Canada? A. Less than 7% B. Between 7% and 13% C. Greater than 13% Please can someone explain why the correct answer is C? I thought that if the CAD is going to depreciate it would have a lower interest rate and the answer would be A. I am obviously not correctly understanding uncovered interest rate parity.
sounds more like an PPP question, i would say higher inflation = higher nominal = depreciation
C) greater than 13 percent bcuz CAD is going to dep compared to the other two currencies. meaning that CAD has higher int rate.
epoh Wrote: ------------------------------------------------------- > C) greater than 13 percent bcuz CAD is going to > dep compared to the other two currencies. meaning > that CAD has higher int rate. if depreciating against Peso (13%) the IR must be greater then 13% the secret is this…these parity relations assume NOMINAL IR’s, NOT REAL. fischer equations says real rates are equal, therefore nominal IR will differ by inflation [aka the inflation differential], thus higher inflation [as per PPP] will depreciate the currency, remembering that nominal IRs = (1+RR)(1+I)
I think the easiest way to remember these types of questions is to relate the forward discount/premium with the interest rate. where: f = Ifc - Idc we are looking for a forwad discount in CAD in relation to both the USD and MXN, so this relation would need to be negative for both from the perspective of the Canadian investor. The highest Ifc is 13% for the MXN, so for the forward to be negative in regards to this the Idc must be greater than 13%
Not to sound like a broken record, but if the CAD is expected to depreciate against the MXN, CAD investors should be compensated with higher interest rates in order to make up for the shortfall in currency return.
Uncovered Interest Parity Equation is: Sn = S0* (1+rA)/(1+rB) Here S0 is spot rate in B:A or A/B now if A is to depreciate wrt to B then you must be able to buy more A per B => Sn > S0 ( A is depreciating - eg S0 is 2HKD/USD, after Depreciation Sn = 3HKD/USD) thus 1+rA must be greater than 1+rB if 1+rA > 1+rB => rA >rB
lets see how many different ways we could says the same ish.