Chapter 8

Your Best Guess: The Interest Rate Parity (IRP)

In This Chapter

arrow Examining the relationship between interest rate parity and the MBOP

arrow Deriving the interest rate parity

arrow Estimating the forward rate

arrow Understanding the difference between covered and uncovered interest arbitrage

arrow Knowing when an arbitrage opportunity exists

This chapter and Chapter 9 aim to accomplish similar goals. Whereas the theoretical models of Chapters 5, 6, and 7 predict the direction of the change in the exchange rate (appreciate or depreciate), the concepts of interest rate parity (IRP) in this chapter and purchasing power parity (PPP) in the next chapter seek to attach a number to the direction of change in the exchange rate. In other words, Chapters 8 and 9 help you not only identify appreciation of the dollar, for example, but also quantify that appreciation.

Although this quantification is an accomplishment, actual changes in exchange rates may not reflect the IRP-suggested changes every time you observe ...

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