Module 5.2: Mark-to-Market Value, and Parity Conditions

Question 1

Mark-to-Market Value

Answer 1

The value of a forward currency contract prior to expiration

Question 2

Mark-to-Market Value Formula

Answer 2

Question 3

Covered interest rate parity

Answer 3

forward premium or discount exactly offsets differences in interest rates

Question 4

Covered interest rate parity formula

Answer 4

Question 5

Uncovered interest rate parity

Answer 5

Expected future spot rates relating to interest rate differentials

Question 6

Uncovered Interest Rate Parity Formula

Answer 6

Question 7

(Domestic) Fisher Relation

Answer 7

the nominal rate of return is (approximately) the sum of the real rate and the expected rate of inflation.

Question 8

(Domestic) Fisher Relation Formula

Answer 8

Question 9

real interest rate parity

Answer 9

real interest rates are assumed to converge across different markets

Question 10

international Fisher effect

Answer 10

tells us that the difference between two countries’ nominal interest rates should be equal to the difference between their expected inflation rates.

Question 11

international Fisher effect formula

Answer 11

Question 12

absolute purchasing power parity

Answer 12

compares the average price of a representative basket of consumption goods between countries

Question 13

absolute purchasing power parity formula

Answer 13

Question 14

Relative purchasing power parity formula

Answer 14

Question 15

Relative purchasing power parity

Answer 15

states that changes in exchange rates should exactly offset the price effects of any inflation differential between two countries

Question 16

ex-ante version

Answer 16

same as relative purchasing power parity except that it uses expected inflation

Question 17

Several observations can be made from the relationships among the various parity conditions:

Answer 17

• Covered interest parity holds by arbitrage. If forward rate parity holds, uncovered interest rate parity also holds (and vice versa).
• Interest rate differentials should mirror inflation differentials. This holds true if the international Fisher relation holds. If that is true, we can also use inflation differentials to forecast future exchange rates—which is the premise of the ex-ante version of PPP.
• If the ex-ante version of relative PPP as well as the international Fisher relation both hold, uncovered interest rate parity will also hold.