CHAPTER 6

Topics in Uncovered Interest Rate Parity

This chapter covers some applications and issues related to the uncovered interest rate parity (UIRP) condition. We first show the expected rate of change of the short-run intrinsic foreign exchange (FX) rate, given the UIRP condition. This concept has important implications in international finance, including converting an asset’s cost of capital from one currency into another.

The chapter also analyzes the impact on the spot FX rate if a currency’s interest rate abruptly changes. This exercise is intended to help us see the dynamic forces that affect FX rates. The chapter also describes Siegel’s paradox, which is a minor mathematical problem for the UIRP theory.

Finally, we cover the idea of ...

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