Guys,
When Schweser is talking about Carry Trade they mention that Covered Interest Rate Parity (CIRP) implies that currency with higher interest rate will trade at a forward discount (Fo < So) and that currency with lower interest rate will trade at forward premium (Fo >So)
Isn’t it the other way around? The currency A (or country A) is in the numerator…
The price Currency is in the numerator while the base currency is in the denominator (P/B method) now.
So both F and S are specified in P/B format.
But isn’t that the way it has always been?
I’m confused.
In the following exercise they have an example where So is BRL/USD 2,41 and interest rate in Brazil is 6% and 1% for the US.
The forward rate calculated is 2.529.
The country with higher interest rate (Brazil) is then trading at a forward premium, since Fo > So.
No?
It is 1 USD=2.41 BRL (in the old interpretation style). (Base Currency = Exchange Rate * Pricing Currency).
so with 6% rate in Brazil and 1 % rate in the US => giving you a forward rate of 2.529 -> 1 USD is now 2.529 BRL.
1 USD is worth MORE BRL. So USD has appreciated but BRL has depreciated. So I would say BRL is trading at a forward discount.
BASE currency would trade at a forward premium (appreciate in value), the Pricing Currency would trade at a discount. (Depreciate in value)
Perfect, now its very clear.
Thanks for the help cpk123.