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Hello, Ryan. Thank you so much for the video! There is one question troubling me for a long time. For the EUR/USD 1.40 to 1.47 case, could you elaborate more on why the higher interest rate in USD would lead to dollar depreciates please? Because in my knowledge, if EUR/USD is 1:1, EUR interest rate is 0 while USD interest rate is 10%, the forward EUR/USD rate should be: spot*(1+interest rate of base)/(1+interest rate of price ccy) which is 1*(1+0)/1.1 so EUR/USD would be 0.91. The 0.91 makes more sense to me as the higher interest rate in USD would lead to USD appreciate while EUR depreciates
Hi @kahowan7505, you've touched on an important point! In theory, higher interest rates in the USD should indeed strengthen the dollar due to the interest rate parity concept you described. However, in practice, if the market anticipates that these high rates are due to inflation concerns or other economic instabilities, it could lead to depreciation instead as investors might foresee a rate cut in the future. This illustrates the complexity of currency movements where multiple factors including market perceptions play a role.
Yes, in the FX spot market, you have ownership of the currency pair you're trading at the time of the transaction. However, it's important to note that this ownership is often transient, as trades typically settle within a couple of days and traders usually don't hold onto the currency itself for long.
Hi Ryan. Since USD/EUR 1.4 is the same as EUR/USD .7143, how do I know if I'm using the correct spot rate? The formula is very easy to remember but when it comes to which rate I'll be using (i.e. USD/EUR 1.4 or EUR/USD .7143), that's when I get confused a lot.
When dealing with currency pairs, the first currency listed is the base currency and the second is the price (or quote) currency. So in USD/EUR, USD is the base and EUR is the price currency, while in EUR/USD, EUR is the base and USD is the price currency. Just know which one is price and which is base, then you can plug into the interest rate parity formula with no mistakes
@@RyanOConnellCFA Thank you, but where I can find the forward exchange rate medium on the market. I must do a linear regression between difference of interest rate and difference of spot and forward exchange rate.
@@andreatorri2030 You can find forward exchange rates from financial market data providers, such as Bloomberg, Reuters, or financial websites that offer forex market information. For your linear regression analysis, you might need historical data, which could be available through financial databases or forex trading platforms that offer historical exchange rate information. Additionally, some economic research websites or central banks' databases may provide this data, particularly for major currency pairs.
"per Euro" = base currency is Euro. It is also traditional convention for EUR and GBP and AUD to be the base currency over others, followed by USD. For example it is standard convention to see EUR/USD quotes, USD/JPY quotes, but never CNY/AUD nor HKD/GBP. (base currency is the first currency before the "/")
Hey mate, I'm not understanding why a currency offering a higher rate of return would lead to a depreciating currency? Wouldn't that mean that more investors invest in the currency offering the higher rate of return => increasing it's price and therefore appreciating the currency?
Hi Ryan, I am confused at the 'interest rates' you refer to. Are these the central banks' base rates you are referring to? In addition to this, the forward rate (in your example $1.40 spot and $1.47 forward) the 1.47 is what you end up paying with a premium included?
Hey Joel! Yes, these interest rates would be the central banks base rates! The forward rate is not a premium, in fact the forward rate can be less than the spot rate. Basically, the forward rate (the rate from 1 year from today) of exchange will differ from the spot rate (todays rate) based on the interest rates in both countries. If it didnt, we would just trade for the currency that pays higher interest and hold it for a year and enter into a forward contract to switch back to the other currency a year later. But this would allow for arbitrage and an efficient market should largely reduce opportunities for arbitrage. Does that make sense?
@@joeldavies6690 No problem, I love getting questions. If you're looking to buy then you're asking. You can sell at the bid or buy at the ask. Ask should be more expensive than bid (the exchange has to get a cut which is the difference between the two)
I can see where you got confused on this one: Forward rate/spot rate = (1 + interest rate price currency)/(1 + interest rate base currency) So to get just the forward rate on the left side of the equation, we need to multiply both sides of the equation by the spot rate to cancel out having the spot rate in the numerator on the left side of the formula (Forward rate/spot rate )*spot rate = forward rate
Im sorry, I’m putting in (1+1.10/1+.05)x(1.40) and I’m getting $4.41? Apologies I know I’m the only one who hasn’t got this and you don’t really have to be giving out basic maths on a UA-cam chat.
According to the interest rate parity condition, the currency with the higher interest rate is expected to depreciate in the future, not appreciate, because the higher interest yield is offset by a decrease in the currency's value over time. In the example I provided, even though the USD has a higher interest rate than the EUR, it is expected to be worth less in the future compared to the EUR, which is correctly reflected in the forward exchange rate calculation (1.47 USD/EUR).
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Are these loan or borrow interest rates?
In this video the rates are agnostic to borrowing or lending and it is assumed for simplicities sake you can borrow or lend at the rate
Hello, Ryan. Thank you so much for the video! There is one question troubling me for a long time.
For the EUR/USD 1.40 to 1.47 case, could you elaborate more on why the higher interest rate in USD would lead to dollar depreciates please?
Because in my knowledge, if EUR/USD is 1:1, EUR interest rate is 0 while USD interest rate is 10%, the forward EUR/USD rate should be:
spot*(1+interest rate of base)/(1+interest rate of price ccy) which is 1*(1+0)/1.1 so EUR/USD would be 0.91. The 0.91 makes more sense to me as the higher interest rate in USD would lead to USD appreciate while EUR depreciates
Hi @kahowan7505, you've touched on an important point! In theory, higher interest rates in the USD should indeed strengthen the dollar due to the interest rate parity concept you described. However, in practice, if the market anticipates that these high rates are due to inflation concerns or other economic instabilities, it could lead to depreciation instead as investors might foresee a rate cut in the future. This illustrates the complexity of currency movements where multiple factors including market perceptions play a role.
Do i have ownership when i trade fx spot market contract
Yes, in the FX spot market, you have ownership of the currency pair you're trading at the time of the transaction. However, it's important to note that this ownership is often transient, as trades typically settle within a couple of days and traders usually don't hold onto the currency itself for long.
@@RyanOConnellCFA thank you man for the information im gonna sub 😊
@@holio1009 Much appreciated and it's my pleasure!
Greatly appreciated!!
Thank you!
great ... understood all ...!
I'm glad to hear that Grace!
Hi Ryan. Since USD/EUR 1.4 is the same as EUR/USD .7143, how do I know if I'm using the correct spot rate? The formula is very easy to remember but when it comes to which rate I'll be using (i.e. USD/EUR 1.4 or EUR/USD .7143), that's when I get confused a lot.
When dealing with currency pairs, the first currency listed is the base currency and the second is the price (or quote) currency. So in USD/EUR, USD is the base and EUR is the price currency, while in EUR/USD, EUR is the base and USD is the price currency. Just know which one is price and which is base, then you can plug into the interest rate parity formula with no mistakes
Where can I find the forward exchange rate?
Hello, @218 is when I begin to discuss that
@@RyanOConnellCFA Thank you, but where I can find the forward exchange rate medium on the market. I must do a linear regression between difference of interest rate and difference of spot and forward exchange rate.
@@andreatorri2030 You can find forward exchange rates from financial market data providers, such as Bloomberg, Reuters, or financial websites that offer forex market information. For your linear regression analysis, you might need historical data, which could be available through financial databases or forex trading platforms that offer historical exchange rate information.
Additionally, some economic research websites or central banks' databases may provide this data, particularly for major currency pairs.
Great video and awesome explanation. Why is the Euro the base currency? I thought the domestic would be the base?
"per Euro" = base currency is Euro.
It is also traditional convention for EUR and GBP and AUD to be the base currency over others, followed by USD.
For example it is standard convention to see EUR/USD quotes, USD/JPY quotes, but never CNY/AUD nor HKD/GBP. (base currency is the first currency before the "/")
We could have quoted it either way! In this example, I used EUR as the base currency but it could have easily been flipped around
Great work!! Thanks
Thanks Raul!
Hey mate, I'm not understanding why a currency offering a higher rate of return would lead to a depreciating currency? Wouldn't that mean that more investors invest in the currency offering the higher rate of return => increasing it's price and therefore appreciating the currency?
They would and after that time period People would sell back that USD for EUR, making USD depreciate
thank you!!!! really helped
Absolutely!
Hi Ryan, I am confused at the 'interest rates' you refer to. Are these the central banks' base rates you are referring to? In addition to this, the forward rate (in your example $1.40 spot and $1.47 forward) the 1.47 is what you end up paying with a premium included?
Hey Joel! Yes, these interest rates would be the central banks base rates! The forward rate is not a premium, in fact the forward rate can be less than the spot rate. Basically, the forward rate (the rate from 1 year from today) of exchange will differ from the spot rate (todays rate) based on the interest rates in both countries. If it didnt, we would just trade for the currency that pays higher interest and hold it for a year and enter into a forward contract to switch back to the other currency a year later. But this would allow for arbitrage and an efficient market should largely reduce opportunities for arbitrage. Does that make sense?
Okay great! I'm wondering, if I'm a UK company, buying € options on eur/gbp, am I calling or putting ?? I can't seem to grasp which one I am doing
Or like wise if I am a UK company buying € on eur/gbp, am I bidding or asking ? Sorry about the questions
@@joeldavies6690 Joel, it depends on what side the company needs. Does the company need to sell Euros for GBP at or future date or vice versa?
@@joeldavies6690 No problem, I love getting questions. If you're looking to buy then you're asking. You can sell at the bid or buy at the ask. Ask should be more expensive than bid (the exchange has to get a cut which is the difference between the two)
This is gold
Much appreciated!
Im sorry, was with you until “we have to multiply both sides” not sure what is multiplying what.
I can see where you got confused on this one:
Forward rate/spot rate = (1 + interest rate price currency)/(1 + interest rate base currency)
So to get just the forward rate on the left side of the equation, we need to multiply both sides of the equation by the spot rate to cancel out having the spot rate in the numerator on the left side of the formula
(Forward rate/spot rate )*spot rate = forward rate
Im sorry, I’m putting in (1+1.10/1+.05)x(1.40) and I’m getting $4.41?
Apologies I know I’m the only one who hasn’t got this and you don’t really have to be giving out basic maths on a UA-cam chat.
Now problem, you are likely putting the inputs in incorrectly. try using (1.1/1.05)*1.4
Supernatural
you making a mistake IMHO. the USD cant be worth less in the future if it paying higher interest than the EUR, ceteris paribus.
According to the interest rate parity condition, the currency with the higher interest rate is expected to depreciate in the future, not appreciate, because the higher interest yield is offset by a decrease in the currency's value over time. In the example I provided, even though the USD has a higher interest rate than the EUR, it is expected to be worth less in the future compared to the EUR, which is correctly reflected in the forward exchange rate calculation (1.47 USD/EUR).
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