Analyze_This

Brace yourselves for a really dumb/basic i-rate parity question that I should have learned at LI or LII...

Why does the forward rate decrease by 1% to reflect the 1% higher rate in the UK? And does the spot price increase by 1%?

My rough understanding is that at t=0, when the 1% difference in rates becomes apparent, investors will want to hold Pounds to earn the 1% higher rate, so they will buy Pounds and invest for one year. At t=1, they will need to exit this position, requiring them to sell Pounds and buy back their original currency. I-rate parity suggests the spot and future prices should adjust to eliminate the arbitrage opportunity...

does any of that sound right?

Edit: can't speak english very well.



Edited 1 time(s). Last edit at Monday, April 20, 2009 at 05:08PM by ilvino.