CHAPTER 5
Interest Rates and Foreign Exchange
In addition to the purchasing power approach, we can view intrinsic foreign exchange (FX) rates in terms of financial assets, particularly in terms of interest rates. This chapter introduces the role of interest rates in intrinsic FX valuation. As we said, managers need to understand when an FX rate is misvalued to optimize risk management, capital structure, and capital investment decisions.
An intrinsic FX rate that is consistent with valuation in financial markets may be thought of as a short-run intrinsic FX rate. Note that there can simultaneously be both a long-run (goods market) intrinsic spot FX rate and a short-run (financial market) intrinsic spot FX rate. As we'll see, these two intrinsic ...
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