We can say that the real interest rate differences are normal and the small standard deviation of 0.0114065 tells that most of the interest rate values are close to the mean i.e. -0.00259576 or -0.2595%. FORWARD PARITY (FP) Next, examine the forward parity condition of exchange rates. First, calculate the natural log of the spot rate and 90 day forward rates in columns N and O respectively. To do this, use the @LN(x) function, where x is the spot rate. Then, in column P, calculate the deviation from forward rate parity. To do this, simply subtract n-log spot rate three months forward from n-log 90 day forward rate in the current month. The formula should be +O11-N14.
Based on your analysis, how well does the forward exchange rate predict the future spot rate 90 days later? Look at the graph 5-DEV-FP to support your conclusion. Since we know that the forward parity states that the forward rate is an unbiased indicator of the future spot exchange rate and according to the graph this is quite obvious since deviations are small and of the type 0.0xx. The mean of the deviation is a small of -0.0019 which could be approximated to 0.0 for the purpose of ease. Hence we can say that the data is accurate up to a greater extend and one can take good spot decisions looking at the forward exchange rates. However we find that in few months the deviation is of the type 0.1xx but this could be assumed as the uncontrolled component that the markets offer with time and not everything could be predicted.
INTEREST RATE PARITY (IRP)
Interest rate parity says that the difference between nominal yen and dollar interest rates is equal to the forward exchange rate premium or discount between the yen and the dollar. To examine interest rate parity, first calculate the nominal interest rate differential in column Q by subtracting the 90 day Eurodollar rate from the 90 day Euroyen rate. Build a graph to illustrate IRP. Finally, in column R, calculate the difference by subtracting the nominal rate from the forward premium. To compare this with the forward exchange rate premium, look at the graph named
6-INT-PARITY. PURCHASING POWER PARITY (PPP)
Purchasing power parity says that the rate of exchange between two currencies should equal the difference in inflation rates between the two economies in question. If PPP holds, the following formula for deviations from PPP should equal zero: (Japan CPI)-(US CPI)-(N Log Spot 3 Months Out – N-Log Spot Current) Inflation rate of Japan shows sharp peaks ( up and down) indicative of inconsistency in the inflation rates and thus we can say that the economy experienced sharp rise n dip and hence the consumer purchasing power kept changing throughout the duration.
Inflation rates in US though not ideally consistent however experienced a comparative consistent trend and there were no sharp negative dips whatsoever. Therefore we can say that spot exchange rates did not ideally change for Japanese Yen and US dollars in accordance with the change in their inflation rates. The two very different kinds of economies thus do not show a PPP and the same is evident from the graphs with positive -negative waves as well. Questions from the case: It was in these circumstances that Maria Mï¿½ndez was asked to address the question of whether real capital costs had been lower in some currencies than others during the previous decade.
Whether there appeared to have been timing opportunities such as the treasurer had recently tried to exploit. She wondered under what circumstances she should expect the bank to prefer to borrow in one currency rather than another. Moreover, if a particular currency did appear to be cheaper at a given time, could the opportunity have been exploited without hindsight? If so, how? Finally, how long might such an opportunity persist? The results of the analysis would affect not only the choice of currency for the bank’s next issue, but also the larger debate about the bank’s borrowing strategy.
First, as to avoid further criticism it must stick to the company strategy and decide to base its decisions either by monitoring the time or taking into greater consideration the internal targets. This would help build a stronger base for the Bank and also to analyze any discrepancies that might occur in future. Implications: Currency with the lower interest rate expected to appreciate relative to one with a higher rate.