Download - interest rate parity
RMB forwardsAround the Interest Rate Parity
Interest rate parity (IRP)According to the theory, forward rate is determined by the interest rate difference between two countries. The rate reaches equilibrium when no arbitrage return can be obtained
- The 3 month forward rate will be used in the following study
The theory often does not hold due to imperfect capital circulation, risk premium, and external shocks (e.g. market panic)
Risk premium can be isolated by referring to Australia’s case
Australia case• The deviance from IRP is small, around 200bp• Deviance hiked in 2000 and 2007• Dot.com bubble and 08 financial crisis• Return to 20bp very quickly (around 2 years)
1/2/95
7/2/95
1/2/96
7/2/96
1/2/97
7/2/97
1/2/98
7/2/98
1/2/99
7/2/99
1/2/00
7/2/00
1/2/01
7/2/01
1/2/02
7/2/02
1/2/03
7/2/03
1/2/04
7/2/04
1/2/05
7/2/05
1/2/06
7/2/06
1/2/07
7/2/07
1/2/08
7/2/08
1/2/09
7/2/09
1/2/10
7/2/10
1/2/11
7/2/11
1/2/12
7/2/12
1/2/13
7/2/13
1/2/14
7/2/14
1/2/15
7/2/15
-40
-20
0
20
40
60
80
3M differene(BPS)
3M differene(BPS)
Australia case• AUD is known for its liquidity and a well-developed market• A stable 20bp deviation can thus be approximated to be the risk
premium• The case in China, however, is much more complex
China case
4/20/2
006
6/22/2
006
8/24/2
006
10/26/2
006
12/28/2
006
3/1/2
007
5/3/2
007
7/5/2
007
9/6/2
007
11/8/2
007
1/10/2
008
3/13/2
008
5/15/2
008
7/17/2
008
9/18/2
008
11/20/2
008
1/22/2
009
3/26/2
009
5/28/2
009
7/30/2
009
10/1/2
009
12/3/2
009
2/4/2
010
4/8/2
010
6/10/2
010
8/12/2
010
10/14/2
010
12/16/2
010
2/17/2
011
4/21/2
011
6/23/2
011
8/25/2
011
10/27/2
011
12/29/2
011
3/1/2
012
5/3/2
012
7/5/2
012
9/6/2
012
11/8/2
012
1/10/2
013
3/14/2
013
5/16/2
013
7/18/2
013
9/19/2
013
11/21/2
013
1/23/2
014
3/27/2
014
5/29/2
014
7/31/2
014
10/2/2
014
12/4/2
014
2/5/2
015
4/9/2
015
6/11/2
0156
6.5
7
7.5
8
8.5
-3000
-2000
-1000
0
1000
2000
3000
4000
5000
China 3M forward rate
real theory difference
Source: Bloomberg & Wind. Data as of 5/8/15
China case• 1. A larger deviance from IRP very likely caused by the capital control
and the under-developed market system• 2. Reverse of the deviation from negative to positive• Market values USD higher than the theory
4/20/2
006
6/22/2
006
8/24/2
006
10/26/2
006
12/28/2
006
3/1/2
007
5/3/2
007
7/5/2
007
9/6/2
007
11/8/2
007
1/10/2
008
3/13/2
008
5/15/2
008
7/17/2
008
9/18/2
008
11/20/2
008
1/22/2
009
3/26/2
009
5/28/2
009
7/30/2
009
10/1/2
009
12/3/2
009
2/4/2
010
4/8/2
010
6/10/2
010
8/12/2
010
10/14/2
010
12/16/2
010
2/17/2
011
4/21/2
011
6/23/2
011
8/25/2
011
10/27/2
011
12/29/2
011
3/1/2
012
5/3/2
012
7/5/2
012
9/6/2
012
11/8/2
012
1/10/2
013
3/14/2
013
5/16/2
013
7/18/2
013
9/19/2
013
11/21/2
013
1/23/2
014
3/27/2
014
5/29/2
014
7/31/2
014
10/2/2
014
12/4/2
014
2/5/2
015
4/9/2
015
6/11/2
0156
6.5
7
7.5
8
8.5
-3000-2000-1000010002000300040005000
China 3M forward rate
real theory difference
Source: Bloomberg & Wind. Data as of 5/8/15
China case• The deviance rises from September 2007 as well as March 2008• Caused by market expectation that IRP does not captured
4/20/2
006
9/14/2
006
2/8/2
007
7/5/2
007
11/29/2
007
4/24/2
008
9/18/2
008
2/12/2
009
7/9/2
009
12/3/2
009
4/29/2
010
9/23/2
010
2/17/2
011
7/14/2
011
12/8/2
011
5/3/2
012
9/27/2
012
2/21/2
013
7/18/2
013
12/12/2
013
5/8/2
014
10/2/2
014
2/26/2
015
7/23/2
0156
6.5
7
7.5
8
8.5
-3000-2000-1000010002000300040005000
China deviance from IRP
real theory difference
4/20/2
006
8/24/2
006
12/28/2
006
5/3/2
007
9/6/2
007
1/10/2
008
5/15/2
008
9/18/2008
1/22/2009
5/28/2
009
10/1/2
009
2/4/2
010
6/10/2010
10/14/2
010
2/17/2
011
6/23/2
011
10/27/2
011
3/1/2
012
7/5/2
012
11/8/2
012
3/14/2
013
7/18/2
013
11/21/2
013
3/27/2
014
7/31/2
014
12/4/2014
4/9/2
015-10123456789
interest rate and spot
US 3M i China 3M i spot
Source: Bloomberg & Wind. Data as of 5/8/15
China case• 2007 Sep PBOC raise RMB deposit basis rate and Fed lowered USD
basis rate• It was the beginning of the 08 crisis and market expected USD to further
devalue; real rate values USD lower than IRP
4/20/2
006
9/14/2
006
2/8/2
007
7/5/2
007
11/29/2
007
4/24/2
008
9/18/2
008
2/12/2
009
7/9/2
009
12/3/2
009
4/29/2
010
9/23/2
010
2/17/2
011
7/14/2
011
12/8/2
011
5/3/2
012
9/27/2
012
2/21/2
013
7/18/2
013
12/12/2
013
5/8/2
014
10/2/2
014
2/26/2
015
7/23/2
0156
6.5
7
7.5
8
8.5
-3000-2000-1000010002000300040005000
China deviance from IRP
real theory difference
4/20/2
006
8/24/2
006
12/28/2
006
5/3/2
007
9/6/2
007
1/10/2
008
5/15/2
008
9/18/2008
1/22/2009
5/28/2
009
10/1/2
009
2/4/2
010
6/10/2010
10/14/2
010
2/17/2
011
6/23/2
011
10/27/2
011
3/1/2
012
7/5/2
012
11/8/2
012
3/14/2
013
7/18/2
013
11/21/2
013
3/27/2
014
7/31/2
014
12/4/2014
4/9/2
015-10123456789
interest rate and spot
US 3M i China 3M i spot
Source: Bloomberg & Wind. Data as of 5/8/15
China case• By 2008 March, Fed has already lowered the rate 6 times• Crisis was almost resolved and market expect an USD appreciation• Market valued the USD higher than IRP and induced the negative deviation
4/20/2
006
9/14/2
006
2/8/2
007
7/5/2
007
11/29/2
007
4/24/2
008
9/18/2
008
2/12/2
009
7/9/2
009
12/3/2
009
4/29/2
010
9/23/2
010
2/17/2
011
7/14/2
011
12/8/2
011
5/3/2
012
9/27/2
012
2/21/2
013
7/18/2
013
12/12/2
013
5/8/2
014
10/2/2
014
2/26/2
015
7/23/2
0156
6.5
7
7.5
8
8.5
-3000-2000-1000010002000300040005000
China deviance from IRP
real theory difference
4/20/2
006
8/24/2
006
12/28/2
006
5/3/2
007
9/6/2
007
1/10/2
008
5/15/2
008
9/18/2008
1/22/2009
5/28/2
009
10/1/2
009
2/4/2
010
6/10/2010
10/14/2
010
2/17/2
011
6/23/2
011
10/27/2
011
3/1/2
012
7/5/2
012
11/8/2
012
3/14/2
013
7/18/2
013
11/21/2
013
3/27/2
014
7/31/2
014
12/4/2014
4/9/2
015-10123456789
interest rate and spot
US 3M i China 3M i spot
Source: Bloomberg & Wind. Data as of 5/8/15
Implication of China’s deviation• Composition of the deviance:• From the previous slides, we can see that market expectation was vital• The deviation can be approximated as the difference between market’s
expectation on RMB and on yields of US assets (what IRP based)
• Nature of RMB as a Forex:• Young; lack historical trend to be studied by investors• Intervention by the PBOC on the exchange rate against US
Deviance as an indicator• Deviance predicting future trend of spot rate:
• Investors lack historical data and can only refer to previous spot rate changes (which they presume is the result of PBOC’s intervention)
• The deviance between real forward rate and IRP can isolates the factors IRP doesn’t consider:• Government intervention and market sentiments
• The factors isolated determines RMB trading activities and thus the spot rate• A larger deviance(theory – real) means market expecting the spot rate to drop given PBOC’s adjustments in
previous days• The chart below illustrate the spot rate’s slightly lag, negative-correlated movement with the deviance
4/20/2
006
6/22/2
006
8/24/2006
10/26/2
006
12/28/2
006
3/1/2
007
5/3/2
007
7/5/2
007
9/6/2
007
11/8/2007
1/10/2
008
3/13/2
008
5/15/2
008
7/17/2
008
9/18/2008
11/20/2
008
1/22/2
009
3/26/2
009
5/28/2
009
7/30/2009
10/1/2009
12/3/2
009
2/4/2
010
4/8/2
010
6/10/2
010
8/12/2010
10/14/2
010
12/16/2
010
2/17/2
011
4/21/2
011
6/23/2011
8/25/2011
10/27/2
011
12/29/2
011
3/1/2
012
5/3/2
012
7/5/2
012
9/6/2
012
11/8/2
012
1/10/2
013
3/14/2
013
5/16/2
013
7/18/2
013
9/19/2
013
11/21/2
013
1/23/2014
3/27/2
014
5/29/2
014
7/31/2
014
10/2/2
014
12/4/2014
2/5/2
015
4/9/2
015
6/11/2
0156
6.2
6.4
6.6
6.8
7
7.2
7.4
7.6
7.8
8
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
0.5
Deviaiton from IRP and spot rate
spot 3M diffSource: Bloomberg & Wind. Data as of 5/8/15
Profit with NDF• Profit formula: • Total profit = offshore NDF – spot + onshore rmb deposit yield – offshore foreign currency loan
interest (also deduct transaction fee)• Shorter term NDF has a very small profit (~0) and 1 year NDF may yield
certain profit yet subjected to larger transaction cost• Longer term operation with NDF is recommended under interest rate
fluctuation
6/30/2009
10/13/2
009
1/26/2
010
5/11/2
010
8/24/2010
12/7/2
010
3/22/2
011
7/5/2
011
10/18/2
011
1/31/2
012
5/15/2
012
8/28/2012
12/11/2
012
3/26/2013
7/9/2
013
10/22/2
013
2/4/2
014
5/20/2
014
9/2/2
014
12/16/2
014
3/31/2
015
7/14/2
015
-0.2
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
0.2 6M NDF profit
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
3M NDF profit
6/29/2009 9/6/2010 11/14/2011 1/21/2013 3/31/2014 6/8/2015
-0.25-0.2
-0.15-0.1
-0.050
0.050.1
0.150.2
0.25
1y NDF profit
Source: Bloomberg & Wind. Data as of 5/8/15
Hedging with NDF• NDF is very sensitive to external factors and market expectations• Hedging/profiting can be achieved by holding opposite positions of both NDF and onshore
forwards • When NDF appreciate against onshore deliverable forward (DF), investor can short USD and
long RMB via DF and long USD and short RMB via NDF
8/4/2
011
8/30/2
011
9/25/2
011
10/21/2
011
11/16/2
011
12/12/2
011
1/7/2
012
2/2/2
012
2/28/2
012
3/25/2012
4/20/2
012
5/16/2012
6/11/2
012
7/7/2
012
8/2/2
012
8/28/2
012
9/23/2012
10/19/2
012
11/14/2
012
12/10/2
012
1/5/2
013
1/31/2
013
2/26/2
013
3/24/2
013
4/19/2
013
5/15/2013
6/10/2
013
7/6/2
013
8/1/2
013
8/27/2
013
9/22/2013
10/18/2
013
11/13/2
013
12/9/2
013
1/4/2
014
1/30/2
014
2/25/2
014
3/23/2
014
4/18/2014
5/14/2
014
6/9/2
014
7/5/2
014
7/31/2
014
8/26/2014
9/21/2
014
10/17/2
014
11/12/2
014
12/8/2
014
1/3/2
015
1/29/2
015
2/24/2
015
3/22/2
015
4/17/2
015
5/13/2
015
6/8/2
015
7/4/2
015
7/30/2015
-1500
-1000
-500
0
500
1000
1500
3M NDF-onshore spread
Source: Bloomberg & Wind. Data as of 5/8/15
RMB prospect• In the late 2015 the deviance shows a falling trend• 3 month forward rate exceeds 3 month rate by IRP by around 600bp
• Market expects a devaluation of RMB• The recent RMB devaluation can thus fulfill the expectation and
according to previous discussion may even lower the spot rate later
4/20/2006
8/10/2
006
11/30/2
006
3/22/2
007
7/12/2
007
11/1/2
007
2/21/2
008
6/12/2
008
10/2/2
008
1/22/2
009
5/14/2009
9/3/2
009
12/24/2
009
4/15/2
010
8/5/2
010
11/25/2
010
3/17/2011
7/7/2
011
10/27/2
011
2/16/2
012
6/7/2
012
9/27/2
012
1/17/2
013
5/9/2
013
8/29/2
013
12/19/2
013
4/10/2014
7/31/2
014
11/20/2
014
3/12/2015
7/2/2
015
-4000
-3000
-2000
-1000
0
1000
2000
3000
3M-spot spread
1/1/2
015
1/8/2
015
1/15/2
015
1/22/2
015
1/29/2
015
2/5/2
015
2/12/2
015
2/19/2
015
2/26/2015
3/5/2
015
3/12/2
015
3/19/2015
3/26/2015
4/2/2
015
4/9/2
015
4/16/2
015
4/23/2
015
4/30/2
015
5/7/2
015
5/14/2
015
5/21/2
015
5/28/2015
6/4/2
015
6/11/2
015
6/18/2
015
6/25/2015
7/2/2
015
7/9/2
015
7/16/2015
7/23/2015
7/30/2
015
-800
-700
-600
-500
-400
-300
-200
-100
0
100
200
2015 spread
Source: Bloomberg & Wind. Data as of 5/8/15
RMB prospect• Trend of the deviance from IRP, and thus the spot rate, from can be predicted given the
expectation non PBOC’s policy• A loose monetary policy may stirred expectation of devaluation and bigger deviance• The internationalization and liberalization of RMB, however, may gradually close the deviance
to near AUD’s level, and produced a predictable trend• External shocks, however, are very likely to occur and can hinder the above theories.
0.9
1.4
1.9
2.4
2.9
-200-1000100200300400500600700
Aus deviance from IRP
real theory difference( right axis)
4/20/2
006
8/31/2
006
1/11/2
007
5/24/2
007
10/4/2
007
2/14/2
008
6/26/2
008
11/6/2
008
3/19/2
009
7/30/2
009
12/10/2
009
4/22/2
010
9/2/2
010
1/13/2
011
5/26/2
011
10/6/2
011
2/16/2
012
6/28/2
012
11/8/2
012
3/21/2
013
8/1/2
013
12/12/2
013
4/24/2
014
9/4/2
014
1/15/2
015
5/28/2
0156
6.5
7
7.5
8
8.5
-3000
-2000
-1000
0
1000
2000
3000
4000
5000
China deviance from IRP
real theory difference
Source: Bloomberg & Wind. Data as of 5/8/15
