Currency management - Reading 18

S2000magician · February 2, 2016, 4:57am

If you buy USD1.00 you should sell USD_ 1.02 _ forward, as that’s what it will be worth (risk-free) in one year.

MrSmart · February 2, 2016, 9:17am

Ah gotcha, so forward contracts must be priced according to the CIRP, or else arbitrage traders will exploit the mispricing making it eventually trade at the AFP?

S2000magician · February 2, 2016, 4:14pm

MrSmart:

S2000magician:

MrSmart:

S2000magician:

MrSmart:

S2000magician:

MrSmart:

^ I don’t think it’s that simple either. You have a better chance of capitalizing on lower realized inflation.

Within the narrow context of the section I quoted, it is that simple: he was talking about arbitrage, which requires _ covered _ interest rate parity.

There’s a 2 minute difference between both our posts.

If I sell 1 USD at a 1-year fwd price @ 8.62 RMB/USD, the spot rate is 8 RMB/USD, and the interest rates are 10% and 2% resepectively. Then, I borrow 8 RMB and buy 1 USD.

If you buy USD1.00 you should sell USD_ 1.02 _ forward, as that’s what it will be worth (risk-free) in one year.

Ah gotcha, so forward contracts must be priced according to the CIRP, or else arbitrage traders will exploit the mispricing making it eventually trade at the AFP?

Bingo!