COVERED AND UNCOVERED PARITY

Covered and Uncovered Parity

Covered and Uncovered Parity

Aparity status asserting that the distinction in interest rates between two countries is equal to the anticipated change in exchange rates between the nations' currencies. If this parity does not exist, there is an opportunity to make a profit.

"i1" represents the interest rate of country 1"i2" represents the interest rate of country 2"E(e)" represents the expected rate of change in the exchange rate

Covered Parity

Under enclosed parity, there is no inducement to scrounge money from, say, the United States, alter it to Canadian dollars while going into a ahead exchange affirmation, then lend it to Canadians at higher interest rates because the distinction between the forward and location rates would be the identical as the distinction between the two interest rates.

Uncovered Parity

Uncovered parity does not use ahead exchange rates, but rather the anticipated change in location rates. For there to be promise for earnings, the interest rates should be higher than the expected change in profits. Uncovered parity uses estimates rather than genuine agreement charges, so exploiting the lack of it is riskier.

The theory of Purchasing Power Parity (PPP) is not appropriate to foreign exchange rate determination. One of the problems of using PPP is that it is primarilly focuses on differences of goods and service prices and it does not pay attention on international capital flows. After World War II, the foreign exchange market has spread quickly and it has enabled many foreign exchange transactions among countries, throughout the world and in any amount. This fact essentially supports the speculations about converting money from one currency to another dependent on the expected rate of return.

The theory of covered interest rate parity was modeled to understand the relation between the spot exchange rate, the forward exchange rate and the interest rates in the two countries in a time period.

I have conceived this essay to research how the czech investor (a funds of 100.000.000CZK owner) can reach and exploit the arbitrage opportunity in the Euroland. It was really problematic to find out information about above mentioned rates in the Czech Republic. There is no information about forward exchange rates. When I tried to contact banks they told me they couldn´t help me (the csob bank operator, 30/10/07) or the other one said I knew more about it than she did (the cs bank operator, 30/10/07). Ultimately, I contacted the group ´patria online´, the membership has to be prepaid to get the information about foreign exchange market. I have dealt with them and got the free limited membership to find out the data for the essay - the information used in this work are found on Patricia online webpages. The Czech Crown is not common, large and frequently traded currency, I have used in this work the indirect quotation.

This essay connects a theory with imagining a situation which poses a reality and is based on the facts (real foreign exchange rates and interest ...