A rational investor in country i, starting with one unit of her home currency, would compare the following two alternatives: firstly, keeping her home currency and earning an annual (continuous) domestic interest rate, [r.sub.D], on their domestic deposits and ending up with [e.sub.rDT] units home currency after 365T days; or secondly, converting her home currency at the spot exchange rate
, [S.sub.t], earning an annual (continuous) foreign interest, [r.sub.F], on deposit in country j, and then after 365T days exchange currency j for currency i at the previously negotiated forward exchange rate, [F.sub.t;t+T].
Masih (1996), "Common Stochastic Trends, Multivariate Market Efficiency and the Temporal Causal Dynamics in a System of Daily Spot Exchange Rates
," Applied Financial Economics 6(6): 495-504.
dollars is estimated to be 15%, and the spot exchange rate
is [S.sup.D/USD] = 11.72.
The model can explain the forward premium puzzle and several other stylized facts related to the joint behavior of forward and spot exchange rates
. It is also consistent with the availability of profitable carry-trade strategies.
where [E.sub.t] ([s.sub.t+k]|[[OMEGA].sub.t]) = logarithm of expected spot exchange rate
at time t + k, based on information known at time t,
RIP theory is a cornerstone of assessing the efficiency of foreign exchange markets, linking interest rates, spot exchange rates
, and foreign exchange rates.
(3) The series of the expected exchange rate (E[S.sub.t+1]) was obtained by forecasting the time series of the spot exchange rate
under the uncovered interest parity.
dollars, which are then converted into local currency units using the spot exchange rate
in relation to the U.S.
Interest Rate Parity is a theory that the differential in the interest rates of similar interest bearing assets of two countries is equal to the differential between the contractual forward exchange rate and the current spot exchange rate
. This condition eliminates the possibility of earning riskless profits from the interest rate differential.
(18) This is to confirm that expectations on spot exchange rate
changes in the near future, a 3-mo horizon, seem to play a more important role than the level of real exchange rates in determining FDI inflows into Korea.
dollars at the end-of-month spot exchange rate
* The Eun and Reswich monetary approach is discussed along with the empirical equation for the natural logarithm of the spot exchange rate
, but none of this material gives management any practical tools with which to run a MNC.