Carry trade

CFA Level III Derivatives
#1

Dear all,

Schweser Bk 4, Pg 104

Q1. I would like to understand as to why in pt 2 ‘uncovered interest rate parity’ is mentioned but the definition is similar to CIRP.

In pt 1 in CIPR, it says ‘The currency with the highest interest rate will trade at a forward discount’ and give Fo

Q2. Per calculatins the quanity of the base currency will be more in Forward than in spot when the interest rate of the base is lower than the pricing(numerator) currency. Then it should be Fo>So and not Fo

Example:

USD/GBP Spot = 10,

Interest USD 5%

Interest GBP 2%

Then

10(1.05)/1.02)= 10.29

Kindly help.

#2

The USD depreciated against the GBP, now it takes 10.29USD for one GBP just like parity predicts. Is it the notation that is the question?

#3

Hi Swaption11, Thank you for your interest

I agree that the USD depreciates, then the schweser should have been written as Fo>So, but it actually says ’ Fo

My disconnect is around the above direction.

Thank you

#4

When using relative currency values i think the intent of the sign is to show they forward price is weaker not in terms of an absolute value like you would think in math. The way you would translate the USD to GBP is that the USD is weaker in the future than today. So technically its future value is less though is is written as an absulte value greater than 10.29 vs. 10. Its just the notation.

#5

The above statement is true, when the higher interest rate currency is the base currency. Fo < So when the base currency is expected to depreciate. If the price currency was expected to depreciate then the opposite would be true, Fo > So.

Your example refers to USD depreciating. USD is set as the price currency in your example. Therefore Fo > So with the USD as a price currency correctly reflects the USD trading at a forward discount. If you made USD the base currency, then you would see Fo < So.