CHAPTER 8

Interest Rates, Inflation and Parity Conditions

The theory of exchange rates

Opening question

“If Vietnamese rates are higher than US rates, should the dong fall?”

In this chapter

Nominal and real interest rates, and the Fisher equation
Covered interest parity: the arbitrage that sets forward rates, with a USD/VND example
Why covered parity has shown small but persistent gaps since 2008
Uncovered interest parity: what higher rates imply for expected depreciation
The forward premium puzzle and the profits it leaves for carry traders
Purchasing power parity, absolute and relative, and the Big Mac test
Real exchange rates and competitiveness
What investors can use from the theory, and the answer for the dong

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This chapter is in the full book

Chapter 1 is free to read online. The full text of chapter 8 — with its tables, figures, worked examples and practice lab — is available in the complete edition of Forex and Crypto Investing: From Theory to Practice (Volume 3, NXW Investment Library).

Read Chapter 1 free Get the full book — contact@nxw.vn

Sections of this chapter

8.1 Four links between rates, prices and currencies

8.2 Nominal rates, real rates and the Fisher equation

8.3 Covered interest parity

8.4 When covered parity bends

8.5 Uncovered interest parity

8.6 The forward premium puzzle

8.7 Purchasing power parity

8.8 Real exchange rates and competitiveness

8.9 Applying the theory: what investors can use

8.10 The dong, rates and the opening question

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