International Finance Chapter 4

Trend analysis

A forecasting technique that involves collecting data on an asset's price and using these data to try to spot a pattern, or trend, in the movement of the price that would otherwise be obscured by noise.

Charting

A forecasting technique that relies on graphing the price of an asset to show its movement over a specific period of time. The financial data involved often includes the high, low, and closing prices for the asset. Much of the work done with charting is based on trends. Investors hope that the use of a chart can help them to spot an upcoming trend or a historical one that thereby asses where they should be investing and why

Unbiased predictor

A predictive model or method whose prediction errors cancel out over time.

Forward premium

A situation that pertains when the forward rate expressed in dollars is above the spot rate

Forward discount

A situation that pertains when the forward rate expressed in dollars is below the spot rate

Technical analysis

An approach that focuses exclusively on past price and volume movements--while totally ignoring economic and political factors--to forecast future asset prices

Fundamental analysis

An approach to forecasting asset prices that relies on painstaking examination of the macroeconomic variable and policies that are likely to influence the asset's prospects

Inflation differential

Difference in inflation rates between two countries

Interest rate differential

Difference in interest rates between two countries

Black-market exchange rates

Exchange rate at which one can buy or sell a foreign currency in the black market

Market-based forecasts

Forecasts that rely on information already imbedded in market prices

Unbiased forward rate (UFR)

Forward rate should reflect the expected future spot rate on the date of settlement of the forward contract.

Law of one price

In competitive exchange-adjusted prices of identical tradable goods and financial assets must be within transaction costs of equality worldwide.

Model-based forecasts

In the context of this book, currency forecasts based on the use of either fundamental analysis or technical analysis

International Fisher Effect (IFE)

Parity condition that says that the interest differential between two countries should be an unbiased predictor of the future change in the spot rate.

Currency forecasting

Prediction of future exchange rates

Five key theoretical economic relationships resulting from arbitrage activity

Purchasing power parity (PPP) Fisher effect (FE) International Fisher effect (IFE) Interest rate parity (IRP) Forward rates as unbiased predictors of future spot rates (UFR)

Parity Conditions

Relationships that exist in equilibrium between inflation rates, interest rates, and exchange rates--both spot and forward--or two different countries and their currencies

Fisher Effect (FE)

States that the nominal interest differential between two countries should equal the inflation differential between those countries

Nominal exchange rate

The actual exchange rate; it is expressed in current units of currency

Interest Rate Parity (IRP)

The currency of the country with a lower interest rate should be a forward premium in terms of the currency of the country with the higher rate. One of the best-documented relationships in international finance.

Covered interest differential

The difference between the domestic interest rate and the hedged foreign rate

Covered interest arbitrage

The movement of money to take advantage of a covered interest differential

Real Interest Rate

The nominal interest rate adjusted for expected inflation over the life of the loan; it is the exchange rate between current and future goods.

Purchasing Power Parity (PPP)

The notion that the ratio between domestic and foreign price levels should equal the equilibrium exchange rate between domestic and foreign currencies.

Peso Problem

The possibility that during the time period studied, investors anticipated significant events that did not materialize, thereby invalidating statistical inferences based on data drawn from that period.

Nominal Interest rate

The price quoted on lending and borrowing transactions

Arbitrage

The simultaneous purchase and sale of the same assets or commodities on different markets to profit from price discrepancies.

Capital market segmentation

The situation that exists when real interest rates are determined by local credit conditions

Capital market integration

The situation that exists when real interest rates are determined by the GLOBAL supply and GLOBAL demand for funds

Real (inflation-adjusted) exchange rate

The spot rate adjusted for relative price level changes since a base period