Reading 5
Currency Exchange Rates: Understanding Equilibrium Value
3 modules 39 min
0/3
Exam Focus
There’s no fluff here; you need it all. Take it slow and get a good understanding of quotes, currency cross rates, triangular arbitrage, all parity conditions, and their interrelationships. Forecasting exchange rates has important applications for valuation (which is the focus of Level II).
Accordingly, theories of exchange rate determination as well as factors influencing exchange rates are all important. Be prepared to identify warning signs of currency crises.
Modules
- Module 5.1Forex Quotes, Spreads, and Triangular ArbitrageCalculate and interpret the bid and offer spread on a spot or forward currency quotation and describe the factors that affect the bid and offer spread. · Identify a triangular arbitrage opportunity and calculate its profit, given the bid and offer quotations for three currencies. · Explain spot and forward rates and calculate the forward premium/discount for a given currency.10 min · 3 LOS
- Module 5.2Mark to Market Value, and Parity ConditionsCalculate the mark to market value of a forward contract. · Explain international parity conditions (covered and uncovered interest rate parity, forward rate parity, purchasing power parity, and the international Fisher effect). · Describe relations among the international parity conditions. · Evaluate the use of the current spot rate, the forward rate, purchasing power parity, and uncovered interest parity to forecast future spot exchange rates. · Explain approaches to assessing the long run fair value of an exchange rate.14 min · 5 LOS
- Module 5.3Exchange Rate Determinants, Carry Trade, and Central Bank InfluenceDescribe the carry trade and its relation to uncovered interest rate parity and calculate the profit from a carry trade. · Explain how flows in the balance of payment accounts affect currency exchange rates. · Explain the potential effects of monetary and fiscal policy on exchange rates. · Describe objectives of central bank or government intervention and capital controls and describe the effectiveness of intervention and capital controls. · Describe warning signs of a currency crisis.15 min · 5 LOS