Transcription of CHAPTER III EXCHANGE RATES, INTEREST RATES, PRICES …
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CHAPTER III EXCHANGE RATES, INTEREST RATES, PRICES …
CHAPTER III. EXCHANGE rates , INTEREST rates , PRICES AND EXPECTATIONS. This CHAPTER presents simple models of EXCHANGE rate determination. These models apply arbitrage arguments in different contexts to obtain equilibrium relations that determine EXCHANGE rates . In this CHAPTER , we define arbitrage as the activity that takes advantages of pricing mistakes in financial instruments in one or more markets, facing no risk and using no own capital. The no own capital requirement is usually met by buying and selling (or borrowing and lending) the same or equivalent assets or commodities. The no risk requirement is usually met by doing the buying and selling (or borrowing and lending) simultaneously. Obviously, arbitrageurs will engage in this activity only if it is profitable, which means there should be a pricing mistake. Financial markets are said to be in equilibrium if no arbitrage opportunities exist. The equilibrium relations derived in this CHAPTER are called parity relations.
searching for an opportunity to make a risk-free profit, arbitrage will ensure that St (1 + id * T/360) ... We can think of (Ft,T - St) as a profit from the FX swap. ⋄ We get the same IRPT equation if we start the covered strategy by (1) ... the forward rate is the rate that eliminates an arbitrage profit. 1.A.1 IRPT: Assumptions
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