Interest rate parity for determination of the exchange rate
Describe the allegations of interest rate parity for the determination of the exchange rate.
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Supposing that the forward exchange rate is approximately an unbiased predictor of future spot rate, IRP is written as:
S = [(1 + I£)/(1 + I$)]E[St+1?It].
Exchange rate is therefore estimated by relative interest rates, and expected future spot rate, conditional on the available information, It, as of the present time. One therefore may say that the expectation is self-fulfilling. As information set will be constantly updated as soon as the news comes in the market, exchange rate will display the highly dynamic, random behavior.
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Q : Exchange rate changes decreases risk of Would exchange rate changes always raise the risk of the foreign investment? Explain some of the condition under which exchange rate changes can actually decrease the risk of foreign investment.
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