In kaplan notes 2, currency management, here is the extract:
Several factors will impact the eventual path of convergence over the short and intermediate terms. Increase in the value of a currency are associated with currencies:
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that are more undervalued relative to their fundamental value
-
that have the greatest rate of increase in their fundamental value
3. with higher real or nominal interest rates
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with low inflation relative to other countries
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of countries with decreasing risk premiums
For the third bullet point, I understand the currency with higher real interest rate should increase in value, how about nominal? According to CIRP, currency with higher interest rate will decrease in value, please help me understand it and does CIRP apply in short term?
Thanks.
There seems to be an incredible misconception amongst finance people about the rôle of interest rate parity.
Covered interest rate parity does not attempt to predict or estimate _ what future exchange rates will be _.
At all.
Period.
Covered interest rate parity has one goal and one only: _ to prevent arbitrage _.
That’s it.
Period.
What’s really odd is that those same people wouldn’t dream of suggesting that, for example, the forward price on, say, Google stock in any way predicts what the future price of Google stock will be, yet they cling to the (silly . . . dare I say stupid?) idea that the forward price on, say, the GBP/EUR exchange rate is a predictor of the future GBP/EUR exchange rate.
It’s just weird.
So, getting back to your comment, according to CIRP, [the] currency with the higher interest rate _ will not necessarily _ decrease in value; CIRP is completely silent on that topic.
Thx a lot, clear now @S2000magician