Forecasting Exchange

Rate

The Zimbabwe government redenominated the ZWD again on

February 2, 2009 at a rate of 1,000,000,000,000 old ZWD to 1 new

ZWD.

Exchange Rate Determination The Theoretical Thread

International Parity Condition

Chapter 4Eiteman, Stonehill, and Moffet

Forecast change in spot exchange rate

+4%

(yen strengthens)

Forecast difference in rates of inflation

-4%

(less in Japan

Difference in nominal interest rates

-4%

(less in Japan)

Forward premium on foreign currency

+4%

(yen strengthens)

Interest Rate Parity

(D)

International Fisher

Effect (C )

Fischer

Effect (B)

Purchasing Power Parity

(A)

Forward rate as an unbiased predictor (E)

Purchasing Power Parity (Absolute)

If the identical product or service can be sold in two different markets, and no

restrictions exist on the sale or transportation costs of moving the

product between markets, the product’s price should be the same in both

markets. This is called the law of one priceIf the two markets are two different

countries, the product’s price may be stated in different currency terms, but the price of the product should be still

the same

Big Mac PPP (in 2009)

LocalCurrency Dollars PPP Actual

3.57 3.57 1.00 1.00 11.50 2.97 3.2213 3.8704 4.34 3.56 1.2157 1.2200

20,900.00 2.23 5,854.34 9,354.54 320.00 3.55 89.64 90.15

6.77 1.99 1.8964 3.4082 99.39 2.15 27.84 46.33 4.22 2.99 1.1821 1.4110

64.49 1.94 18.06 33.19 5.65 3.65 1.5826 1.5482

Big Mac Prices Exchange Rates

United States Argentina Australia Indonesia

% Under (-)/Over(+)Valuation Against Dollar

-44.36%-39.91%-16.22%-45.58%

Japan Malaysia

Philippines Singapore

2.22%

Sources: The Economist - July, 16th 2009

Countries

Thailand Turkey

-16.77%-0.35%-37.42%-0.57%

Actual USD/GBP and PPP Exchange Rates

Actual Rate

PPP Rate

Actual DEM/USD and PPP Exchange Rates

Actual Rate

PPP Rate

Actual JPY/USD and PPP Exchange Rates

Actual RatePPP Rate

Actual CAD/USD and PPP Exchange Rates

Actual Rate PPP Rate

Actual MXN/USD and PPP Exchange Rates

Actual Rate

PPP Rate

Evidence on PPP• PPP probably doesn’t hold precisely in the real world for

a variety of reasons.– Haircuts cost 10 times as much in the developed world

as in the developing world. (Transaction Costs)– Sticky Prices (Exchange Rate Pass Through) and Non

Competitive Markets– Shipping costs, as well as tariffs and quotas can lead

to deviations from PPP.– Can We Make Profit from It ?

• PPP-determined exchange rates still provide a valuable benchmark.

• PPP holds up well over the very long run but poorly for shorter time periods

• The theory holds better for countries with relatively high rates of inflation and underdeveloped capital markets

Exchange Rate Pass-Through

Relative Purchasing Power Parity

Relative Purchasing Power Parity

The spot exchange rate should change in an amount equal to but in the opposite direction of the difference in

inflation rate between two countries

Beginning Rate – Ending Rate

Ending RateX 100 =

I$ - I¥

1 + I¥

Contoh Soal

• Misalkan tingkat inflasi di Denmark pada tahun 2009 adalah 1.30%, sedangkan tingkat inflasi di India adalah 14.97%. Saat ini kurs yang berlaku adalah Rupee 8.3972/Kroner. Jika relative purchasing power parity berlaku, maka berapa perkiraan kurs tukar tersebut satu tahun mendatang ?

The Fisher Effect

The Fisher Effect states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation

i = r + + r

Where i is the nominal rate of interest, r is the real rate of interest, and is the expected rate of inflation over the period of time for which

funds are to be lent. The final compound term, r, is frequently dropped from consideration due

to its relatively minor value

International Fischer Effect

The spot exchange rate should change in an amount equal to but in the opposite direction of the difference in

interest rate between two countries

Beginning Rate – Ending Rate

Ending RateX 100 =

i$ - i¥

1 + i¥

International Fischer Effect

• Assume that one year interest rates are 3% in US and 5% in the Euro zone. The spot rate between the Euro and the dollar is €1.02/$. Assuming International Fisher Effect holds, what should the €/$ rate be one year hence ?

International Fischer Effect

1.02 - X

X=

3% - 5%

1.071 – 1.05 X = -0.02X

1.03 X = 1.071

X = 1.0398

Dengan demikian, perkiraan rate untuk satu tahun kedepan

adalah Euro 1.0398/$ (jika memenuhi kondisi

International Fischer Effect)

1 + 5%

Interest Rate Parity

The difference in the national interest rates for securities of similar risk and maturity should be equal to, but opposite in sign to, the forward rate discount or premium for the foreign currency, except for transaction costs

Interest Rate Parity

Interest Rate Parity

Forward Premium 3.96% Selisih Interest Rates 4%

Invest dalam US$. Misalkan anda punya uang sebesar CHF 1.480.000 Tukar uang tersebut menjadi dollar, dan mendapatkan US $ 1.000.000 Investasikan uang tersebut dalam US$ dan mendapatkan $ 1.020.000 Tukarkan uang tersebut menjadi CHF, dan anda akan memperoleh $ 1.020.000 X 1.4655 = CHF 1.494.810

Jika anda mendepositokan uang tersebut dalam CHF, maka tiga bulan kemudian, anda akan mendapatkan CHF 1.480.000 X 1.01 = CHF 1.494.800, hanya terdapat selisih sebesar CHF 10 (dianggap tidak material)

Covered Interest Arbitrage

The spot and forward exchange markets are not, however, constantly, in the state of equilibrium. When the market is not in equilibrium, the potential for “riskless” or

arbitrage profit exists. This is called covered interest arbitrage

Covered Interest Arbitrage

Spot Exchange Rate ¥ 106.00/$

6 Month Forward Rate ¥ 103.5/$

6 Month Eurodollar rate 7% per annum

6 month Euroyen rate 4% per annum

Amount of money $ 1.000.000

Covered Interest Arbitrage

Forward Premium 4.83% Selisih Interest Rates 3%

Lebih baik investasikan uang dalam bentuk Yen. Tukarkan uang $ 1.000.000 menjadi 106.000.000 Yen. Investasikan selama 180 hari dan mendapatkan bunga 2% menjadi 108,120,000 Yen. Tukar uang tersebut menjadi dollar (dengan kurs forward), dan anda akan mendapatkan $ 1.044.638.

Pinjaman dalam bentuk dollar, anda bayarkan dengan tingkat bunga 3.5% Jumlah yang anda bayarkan adalah $ 1,035,000. Anda masih mendapat keuntungan sebesar $ 9,638 (tanpa resiko)

Soal Covered Interest Arbitrage

• James Chang, a foreign exchange trader at JP Morgan Chase, can invest $ 5 million or the foreign currency equivalent of the bank’s short term fund in a covered interest arbitrage with Denmark. He has the following quotes

• Can James Chang make a covered interest arbitrage profit ?

Spot Exchange Rate DKr 7.5000/$

Three Month Forward Rate DKr 7.5375/$

Three Month Dollar Interest Rate

3% per year

Three Month Krone Interest Rate

5% per year

Soal Covered Interest Arbitrage

• Assume that interest rates in the US increase to 4% per year (1% for 90 days) but all other rates remain the same. Can James Chang make a 90 day covered interest arbitrage profit ?

• Assume that interest rates in the Euro zone increase to 6% per year (1.5% for 90 days), but all other rates remain the same, including the original US interest rate of 3% per year. Calculate whether James Chang could make a 90-day covered interest arbitrage profit ?

Uncovered Interest Arbitrage

• Investors borrow in countries and currencies exhibiting relatively low interest rates and convert the proceeds into currencies that offer much higher interest rates.

• The transaction is “uncovered” because the investor does not sell the higher yielding currency proceeds forward, choosing to remain uncovered

CarrytradeIstilah carry trade, umumnya, mengacu pada strategi carry trade

dalam perdagangan mata uang. Tak perlu pusing, sejatinya, ini adalah strategi yang sederhana saja. Dalam carry trade, investor meminjam

uang dari negara berbunga rendah dan membiakkannya di negara lain yang masih memasang bunga tinggi. Jadi, ini mirip dengan strategi

"beli di harga rendah dan jual di harga tinggi".Praktik yang paling sering terjadi, investor meminjam dana dari

perbankan Jepang dan kemudian membiakkan dana itu di negara-negara lainnya seperti Australia, Selandia Baru, Amerika, dan juga

Indonesia. Maklum, saat ini bunga di Jepang adalah yang paling rendah, hanya 0,5%.

Ambil contoh, misalnya, seorang investor, meminjam dana di Jepang sebesar 1.000 yen, mengonversinya menjadi rupiah, dan

menginvestasikan di Indonesia. Dengan kurs Rp 73,9 per yen, artinya dalam rupiah dana itu setara dengan Rp 73.900.

Nah, cukup dengan menginvestasikan dana itu di Sertitikat Bank Indonesia (SBI) yang berbunga 8,25%, investor itu sudah akan

langsung menikmati keuntungan bunga 7,75%. Jika ia menginvestasikan dana ini di saham atau obligasi, tentu,

keuntungannya bisa berlipat-lipat.

Icelandic MessUttlesford is just one of dozens of local authorities in Britain that have parked

money, nearly $1.5 billion in total, in Icelandic bank accounts, which were aggressively promoted in this country as high-yielding, but safe, investments.

Well-known charities, nonprofit groups and institutions such as Oxford University and a cancer hospital in northern England put their funds in Icelandic banks. So did

millions of individual Britons, who opened their accounts over the Internet and happily watched their balances grow, at least online. The British government’s own

watchdog agency for public spending confessed to having $16 million tied up in Iceland, whose banking industry was so heavily leveraged that some called the

country one giant Viking hedge fund.When those banks started sinking with stunning swiftness around the beginning of October, Reykjavik was forced to intervene and, essentially, nationalize Iceland’s

largest financial institutions. Investors here in Britain panicked as their money was now frozen by the Icelandic government as it tried to sort out the banking mess. The British government’s pledge to back up individual investors’ deposits up to $80,000

failed to calm nerves, and also did not apply to bodies such as local governments and charities. (quoted from LA Times)

Jawaban Denmark A

Forward Discount (1.99013) Selisih Interest Rate 2

Jika invest dalam DKr maka akan mendapatkan kelebihan tingkat bunga sebesar 2% per tahun, namun ada depresiasi mata uang DKr sebesar 1,97421%. Dengan demikian lebih baik investasi pada Dkr

Tukar uang $ 5.000.000 menjadi DKr dan mendapatkan DKr 37.500.000. Investasikan uang tersebut selama tiga bulan dan mendapatkan uang sebesar 37.500.000 (1+0.0125) = DKr 37.968.750. Tukarkan ke $ dan mendapatkan $ 5.037.513,93

Bayar hutang sebesar $ 5.000.000 (1+0.0075) = $ 5.037.500. Keuntungan yang diperoleh adalah $ 5.037.513,93 - $ 5.037.500 = $ 13.9309

Jawaban Denmark B.a Forward Discount (1.97421) Selisih Interest Rate 1

Jika invest dalam DKr maka akan mendapatkan kelebihan tingkat bunga sebesar 1% per tahun, namun ada depresiasi mata uang DKr sebesar 1,97421%. Dengan demikian lebih baik investasi pada US $

Tukar uang DKr 37.500.000 menjadi US$ dan mendapatkan US $ 5.000.000. Investasikan uang tersebut selama tiga bulan dan mendapatkan uang sebesar $ 5.000.000 (1+0.01) = $ 5.005.000. Tukarkan ke DKr dan mendapatkan DKr 37.723.686

Bayar hutang sebesar $ 37.500.000 (1+0.0125) = $ 37.546.875, atau setara dengan $ 4.981.541,55 Keuntungan yang diperoleh $ 23.458,45

Jawaban Denmark B.b

Forward Discount (1.97421) Selisih Interest Rate 3

Jika invest dalam DKr maka akan mendapatkan kelebihan tingkat bunga sebesar 3% per tahun, namun ada depresiasi mata uang DKr sebesar 1,97421%. Dengan demikian lebih baik investasi pada DKr

Tukar uang $ 5.000.000 menjadi DKr dan mendapatkan DKr 37.500.000. Investasikan uang tersebut selama tiga bulan dan mendapatkan uang sebesar DKr 37.500.000 (1+0.015) $ 38.062.500. Tukarkan ke US $ dan mendapatkan US $ 5.049.952,24

Bayar hutang sebesar $ 5.000.000 (1+0.0075) = $ 5.037.500, dan keuntungan yang diperoleh adalah $ 5.049.952,24 - $ 5.037.500 = $ 12.452,24