Uncovered interest rate parity - what condition is necessary?

CFA Level II Economics
#1

The question is:

For uncovered interest rate parity to hold, which condition is necessary?
A. Forward rate parity holds.
B. Covered interest rate parity holds and ex-ante relative PPP holds.
C. Real interest rate parity and ex-ante relative PPP holds.

The answer given is A, which I understand.

But why is C wrong?

Thanks!

#2

Well they are not a conditions
PPP could hold (based on realtive inflation) and UCIP not.
Reali interesr rates adjustfor inflation UCIP does not

#3

Thanks @MikeyF

I got the attached image from a textbook
Parity

My understanding is:
a) If ex-ante relative PPP holds, that means relative PPP holds, right?
b) And if there is real interest rate parity, it means that international Fisher effect holds, right?

So if (a) and (b) are true, doesn’t that mean that uncovered interest rate parity is also true?

What am I missing here?

Thanks very much in advance!

#4

Since Covered and uncovered interest rate parity would be the same when forward and expected spot rates are the same it’s quite clear the answer should be A.

If Real interest rate parity and ex-ante relative PPP both hold, i think UIRP would be hold. But there two conditions are not necessary. F=E(S) is enough.

#5

Your diagram shows connections not conditions.

Real interest rate parity - that real interest rates will converge - asssumes that UCIP and ex ante PPP hold.

ex-ante PPP says difference s in spot rates id driven by expected chnahes in inflation. Ex-ant PPP is part of answer B and C and is not a CONDITION of UCIP holding.

#6

Thanks @MikeyF and @Okachiang

Is it then correct to say that uncovered interest rate parity holds if, and only if, forward rate parity holds?

And while uncovered interest rate parity holds if real interest rate parity and ex-ante relative PPP hold, uncovered interest rate parity can hold even if real interest rate parity and/or ex-ante relative PPP do not hold?

#7

I think it’s correct.

We start about the relationship with CIRP and UIRP.

The CIRP is guaranteed by forward contracts (F), the UIRP is only an expectation E(S), which may not occur.

If, however, the forward rate is equal to the expected future spot rate, then the UIRP holds. This situation is referred to as forward rate parity .

When UIRP and PPP hold together, then we conclude that expected real interest rates represent expected adjustments in the real exchange rate which is real interest rate parity.

THUS, real interest rate parity is not a condition of the hold of UIRP.

#8

Is it then correct to say that uncovered interest rate parity holds if, and only if , forward rate parity holds?

I would not phrase it that way. They reach the same conclusion but they are not dependany on each other.
How we calcualte the currency move under UCIP and Fwd rate parity is the same.

And while uncovered interest rate parity holds if real interest rate parity and ex-ante relative PPP hold, uncovered interest rate parity can hold even if real interest rate parity and/or ex-ante relative PPP do not hold?

Yes

#9

Thanks very much, @MikeyF and @Okachiang !