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PART IV. THE INTERNATIONAL FISHER EFFECT (IFE)

PART IV. THE INTERNATIONAL FISHER EFFECT (IFE)

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THE INTERNATIONAL FISHER

EFFECT

IFE = PPP + FE

et

(1 + rh )

=

e0

(1 + r f ) t

t



27



THE INTERNATIONAL FISHER

EFFECT

B. Fisher postulated

1. The nominal interest rate

differential should

reflect

the inflation

rate differential.

28



THE INTERNATIONAL FISHER

EFFECT

B. Fisher postulated

2. Expected rates of return

are

equal in the absence

of

government

intervention.

29



THE INTERNATIONAL FISHER

EFFECT

C. Simplified IFE equation:

(if rf is relatively small)



e1 − e0

rh − rf =

e0

30



THE INTERNATIONAL FISHER

EFFECT

D. Implications of IFE

1. Currency with the lower

interest rate

expected to

appreciate relative to one

with a higher rate.



31



THE INTERNATIONAL FISHER

EFFECT

D. Implications of IFE

2. Financial market arbitrage:

insures interest rate differential

is an unbiased

predictor of

change in future spot rate.

32



PART VI. INTEREST RATE PARITY

THEORY

I. INTRODUCTION

A. The Theory states:

the forward rate (F) differs

from the spot rate (S) at

equilibrium by an amount

equal to the interest

differential (rh - rf) between

two countries.

33



INTEREST RATE PARITY

THEORY

2.



The forward premium or

discount equals the interest

rate differential.

(F - S)/S = (rh - rf)

where



rh = the home rate

rf = the foreign rate

34



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PART IV. THE INTERNATIONAL FISHER EFFECT (IFE)

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