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1、ChapterChapter66InterestRateParityInJanuary2011,Brazilianreal-denominatedTreasurybillratesexceeded11%,whereasU.S.Treasurybillrateswerelessthan20basispoints.WhywouldU.S.investorsacceptsuchlowreturnswhentheycouldinvestinBrazil?Firstandforemost,U.S.investorsfacetrans-actionforeign
2、exchangeriskwheninvestinginaBraziliansecurity.TheBrazilianrealmightweaken,wipingouttheinterestgain.Ifinvestorshedgethisrisk,therelativereturnonBrazilianTreasurybillsversusU.S.Treasurybillsisdrivenbyfourvariables:theBrazilianinterestrate,thespotandforwardexchangerates,andtheU.S.
3、interestrate.Afterhedging,perhapsthedollarreturnontheBrazilianTeasurybilllooksmuchlower.Interestrateparitydescribesano-arbitragerelationshipbetweenspotandforwardexchangeratesandthetwonominalinterestratesassociatedwiththesecurrencies.Therela-tionshipiscalledcoveredinterestratepa
4、rity.Thischaptershowsthatinterestrateparityimpliesthatforwardpremiumsanddiscountsintheforeignexchangemarketoffsetinterestdifferentialstoeliminatepossiblearbitragethatwouldarisefromborrowingthelow-interest-ratecurrency,lendingthehigh-interest-ratecurrency,andcoveringtheforeignex
5、changerisk.Interestrateparityisacriticalequilibriumrelationshipininternationalfinance.However,itdoesnotalwaysholdperfectly,andwediscusswhy,whichwillbringusbacktotheBrazilianexampleabove.Theavailabilityofborrowingandlendingopportunitiesindifferentcurrenciesallowsfirmstohedgetran
6、sactionforeignexchangeriskwithmoneymarkethedges.Wedemonstratethatwheninterestrateparityissatisfied,moneymarkethedgesareequivalenttotheforwardmarkethedgesoftransactionexchangeriskthatwerepresentedinChapter3.Moreover,wecanuseinterestrateparitytoderivelong-termforwardexchangerates
7、.Knowledgeoflong-termforwardratesisusefulindevelopingmultiyearforecastsoffutureexchangerates,whichareanimportanttoolinthevaluationofforeignprojects.6.1THETHEORYOFCOVEREDINTERESTRATEPARITYIninternationalmoneymarkets,theinterestratedifferentialbetweentwocurrenciesapproxi-matelyeq
8、ualsthepercentagespreadbetweenthecurrencies’forwardand
