Cartões: IF5 | Quizlet

What is the Law of One Price (LOP)?

Identical or equivalent assets should sell for the same price across markets, otherwise arbitrage exists.

What are international parity relationships?

They are equilibrium relationships linking exchange rates, interest rates, inflation, and expectations, based on no-arbitrage logic.

What are the main IF5 relationships?

IRP, UIP, PPP, Fisher Effect, International Fisher Effect, and Forward Expectations Parity.

What is Interest Rate Parity (IRP)?

A no-arbitrage condition that links spot rates, forward rates, and interest rates in two countries.

What is Covered Interest Arbitrage (CIA)?

Arbitrage that exploits an IRP violation by borrowing in one currency, investing in another, and using a forward contract to eliminate exchange-rate risk.

What is UIP?

Uncovered Interest Parity replaces the forward rate with the expected future spot rate.

What is PPP?

Purchasing Power Parity says exchange rates should reflect relative price levels across countries.

What is the Fisher Effect?

Higher expected inflation leads to a proportionately higher nominal interest rate.

What is the International Fisher Effect (IFE)?

If real rates are equalized internationally, the interest differential reflects the expected inflation differential.

What is Forward Expectations Parity (FEP)?

When combined with the Fisher effect, it implies the forward premium/discount equals the expected exchange-rate change.

IRP formula when exchange rate is quoted as domestic currency per unit of foreign currency?

F = S × (1 + i_domestic) / (1 + i_foreign)

Covered return on foreign investment from the domestic perspective?

(F/S) × (1 + i_foreign) and in equilibrium this must equal (1 + i_domestic).

Absolute PPP formula?

Exchange rate equals the ratio of the two countries' price levels for the same basket.

Relative PPP formula?

Expected exchange-rate change is approximately the inflation differential.

Real exchange rate formula?

q = S × P_foreign / P_domestic under the usual convention in the lecture. If PPP holds exactly, q = 1.

Forward premium/discount formula?

(F - S) / S for the period; annualize if needed by multiplying by 12/n_months or 4 for 3 months, etc. This style appears directly in the TD and exam material.

How do you annualize a 1-month forward premium?

Period premium × 12.

How do you annualize a 3-month forward premium?

Period premium × 4.

If IRP holds, are there arbitrage opportunities?

No. If IRP holds, the market is in equilibrium. This is tested directly in the finals.

If IRP does not hold, what does that imply?

If IRP does not hold, what does that imply?

What is the exam shortcut for deciding where to invest under IRP/CIA?

Compare domestic return 1 + i_domestic with covered foreign return (F/S)(1 + i_foreign). Choose the larger one.

In a CIA problem, if covered foreign return is higher, what is the arbitrage direction?

Borrow domestic, convert to foreign at spot, invest foreign, sell future foreign proceeds forward.

In a CIA problem, if domestic return is higher, what is the reverse strategy?

Borrow foreign, convert to domestic, invest domestic, buy foreign forward to repay the foreign loan. This is the mirror image of the standard CIA logic in the lecture.

What is a favorite exam trap with IRP?

Using the formula with the wrong quote convention. The lecture explicitly warns the formula depends on whether the domestic currency is the base or quote currency.

What is a favorite exam trap with forward premium questions?

Forgetting annualization.

What is the intuition behind PPP?

Countries with higher inflation should see their currencies depreciate over time.

Under relative PPP, if domestic inflation is higher than foreign inflation, what should happen to the domestic currency?

It should depreciate.

What does q = 1 mean?

Real exchange rate parity holds exactly; the basket costs the same in both countries after currency conversion.

What does q > 1 or q < 1 tell you?

PPP is violated; one country's goods are relatively expensive or cheap in real terms depending on the convention used.

Why is the Big Mac Index mentioned in IF5?

As an intuitive PPP illustration showing whether a currency appears overvalued or undervalued. The lecture example says the BRL looked overvalued and thus would be expected to depreciate.

What is the conceptual basis of PPP in the finals?

Law of One Price. This appears directly in a final question.

Does PPP tend to work better in the short run or long run?

Better in the long run; the lecture notes explicitly frame PPP as a long-run force.

Fisher Effect one-line memory?

Nominal interest rate ≈ real rate + expected inflation.

If a country's expected inflation rises, what should happen to its nominal interest rate according to Fisher?

It should rise proportionately.

International Fisher Effect one-line memory?

Interest differentials should reflect inflation differentials and therefore expected exchange-rate changes.

Forward-PPP shortcut?

If PPP and FEP both hold, forward premium/discount should match the expected inflation differential.

What replaces the forward rate in UIP?

The expected future spot rate.

Does UIP hold as tightly as covered IRP?

No. The lecture says UIP often does not hold.

What is a currency carry trade?

Borrow in a low-interest currency and invest in a high-interest currency without hedging exchange-rate risk.

When is a carry trade profitable?

When the interest differential exceeds the appreciation of the funding currency against the investment currency.

Quick intuition: high interest rate currency = always good investment?

Not necessarily; expected depreciation can offset the higher yield. That is exactly the parity logic.

What role do expectations play in exchange-rate determination according to IF5?

A major one; the lecture explicitly says exchange-rate behavior is driven by expectations and news.

Two main reasons IRP may deviate slightly in reality?

Transaction costs and capital controls

How do transaction costs weaken arbitrage?

Borrowing and lending rates differ, and FX trades happen at bid/ask prices rather than mid-rates.

How do capital controls weaken arbitrage?

They restrict cross-border capital flows, taxes, or outright transactions.

If F > S, what does that mean for the base currency?

The base currency is at a forward premium relative to the quote currency, under the quote convention being used. The exams test this wording directly.

If F < S, what does that mean for the base currency?

The base currency is at a forward discount.

What was directly tested in the midterm/final style regarding forward rates?

Interpreting whether USD or another currency is at forward premium/discount from the comparison of spot and forward rates.

Fast rule for quoted pair USDJPY: if forward > spot, what is at premium?

USD is at a forward premium relative to JPY. That exact idea appears in the finals.

How do you compare a domestic investment with a foreign hedged investment?

1.Convert at spot.

2.Grow at foreign interest rate.

3.Convert back at forward.

4.Compare with domestic maturity value.

Standard domestic maturity value?

Initial amount × (1 + i_domestic)

Standard foreign covered maturity value?

Initial domestic amount × (1/S) × (1 + i_foreign) × F under the quote convention used in the

What result should you get if IRP holds exactly?

Domestic maturity value = covered foreign maturity value.

How do you back out the unknown interest rate from IRP?

Rearrange F/S = (1 + i_domestic)/(1 + i_foreign) and solve for the missing rate. That exact style appears in the exams

How do you build forward rates for future project cash flows under IRP?

Roll the forward by the interest differential each period, then multiply each foreign-currency cash flow by the corresponding forward rate.

If a firm will receive foreign currency in the future, what is the simplest hedge?

Sell the foreign currency forward. This is tested in the final set.

If a U.S. firm will receive GBP later and wants downside protection with upside potential, what option should it buy?

A put option on GBP. This appears directly in a final question.

Money market hedge for a foreign-currency receivable?

Borrow the foreign currency today against the receivable, convert to domestic now, invest domestically, then use the future receivable to repay the foreign loan.

Why does IF5 matter for hedging?

Because forward rates and covered cash-flow conversions come directly from parity logic.

Quick tip: what should you compare in IRP questions?

Compare "home deposit return" vs "foreign deposit return after hedging."

Quick tip: what is the biggest source of mistakes in IF5?

Quote convention and annualization. The course materials repeatedly make both relevant.

Quick tip: in PPP, which country's currency tends to depreciate?

The one with higher inflation.

Quick tip: in Fisher, which country tends to have the higher nominal rate?

The one with higher expected inflation.

Quick tip: if the exam says "use EUR as base currency," what should you do first?

Rewrite/interpet the quote carefully before plugging into premium/discount formulas. A past question uses exactly that wording.

Quick tip: if there is no arbitrage, what should be equal?

The domestic risk-free return and the covered foreign risk-free return.

Quick tip: what does a forward premium often signal in exam problems?

A currency with a lower interest rate tends to sell at a forward premium, consistent with IRP.

Quick tip: how are IRP and PPP different in spirit?

IRP links money-market returns and FX; PPP links goods prices and FX.

Quick tip: how are PPP and real exchange rate linked?

PPP holding implies a stable benchmark real exchange rate, equal to 1 under the lecture convention.

Quick tip: why can a high-yield currency still be a bad bet?

Because depreciation can erase the interest advantage.

"If the 3-month forward rate for USDJPY is higher than the spot rate..." What is the standard conclusion?

USD is at a forward premium relative to JPY.

"Which statement about IRP is incorrect?"

"When IRP holds, there are arbitrage opportunities." That statement is false.

"The concept underlying PPP is..."

Law of One Price.

"A project in euros is risk-free and you want CNY cash flows hedged..." What idea should you use?

Convert each future euro cash flow using forward rates implied by IRP.

"A firm has a future GBP receivable and wants fixed USD proceeds..." Which hedge?

Sell GBP forward.

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