W2P3 - NotebookLM Flashcards
What is triangular arbitrage?
Swapping currencies to profit from inconsistent exchange rates. Arbitrageurs exploit these inconsistencies until they disappear due to continuous trading.
Explain the general concept of arbitrage related to bonds.
Identical bonds should have identical prices. If bond A offers a lower return than bond B, its price decreases, increasing its return until it equals bond B’s return.
What is the Uncovered Interest Rate Parity (UIP) condition?
The UIP condition suggests returns on similar assets in different countries should equalize. It helps determine where to invest based on interest rates and expected exchange rate changes.
How is the UIP condition expressed mathematically?
By arbitrage, the return on a UK asset should equal the return on a US asset converted back to British pounds: 1 + i(UK) = (S(t) * (1 + i(US))) / S(t+1).
How can the UIP condition be approximated using natural logarithms?
Because nominal interest rates are relatively small, ln(1 + interest rate) ≈ interest rate. The interest rate differential between foreign and home is approximately equal to the expected change in the exchange rate.
According to the lecture, what happens to the British pound when the Bank of England lowers interest rates, and what are the short and long term effects?
A decrease in UK interest rates leads to an immediate depreciation of the British pound. However, over time, there may be an appreciation.
What drives short-term exchange rate fluctuations?
Market expectations and news.
What factors influence long-term exchange rates?
Factors such as Purchasing Power Parity (PPP) and inter-temporal budget constraints.
What was the effect of the Brexit referendum on the British pound?
The British pound experienced a significant drop following the Brexit referendum, but it recovered over time, especially against the US dollar.
