Interest Rates all over world

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Permalink Reply by David Smart on April 19, 2010 at 3:49pm

Hi Abhiram,

The short and quick answer to your answer is no. Let me give you an example to drive the point.

Currently the interest rates in USA or Japan is close to zero while the interest rate in Australia is 4.25%. So, assuming that I would like to carry trade, I would borrow funds which would be denominated in US Dollars and/or Japanese Yen and invest in Aussie related investments.

Now, for you to assess whether you made a killing (or artbitrage) we need to determine whether you have lost/gain with the movement in interest rates. So, you could have borrowed Japanese Yen when the exchnage rate was 94 and repay the funds back at 92. So, effectively, your cost of funds is round 2% (due to the appreciation of the Yen) and the near interest rate on the Japanse Yen.

You should also consider that there will be movement in the Aussie exchange rate. You could have invested when the rate was 0.90. There will be other investors who are also participating in the carry trade thereby resulting in the Aussie rate to appreciate to 0.92. So, your returns would be 4.25% less the appreciation of the Aussie rate of around 2%.

Your net return for your Australian investment would therefore be 2.25% less 2% cost of funding resulting in a return which is almost negligible.

So, I said no because there are millions of individuals (e.g. currency traders in banks) who are seeking out such opportunities like I have explained above. This will result in the differences in exchange rates (e.g. between the US Dollar/Japanese Yen and Aussie Dollar) to reflect the differences in exchange rates. Of course, finance professionals will summarise what am saying into three words - interest rate parity.

Let me know if that makes sense to you.

Regards

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Permalink Reply by Abhiram on June 26, 2010 at 7:10am

Thanks a lot...

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Permalink Reply by Cale Bennett on June 14, 2010 at 7:38pm

Hi Abhiram,

David is correct, from a theoretical perspective.

There are definitely opportunities for lowering funding costs by accessing different markets, but a lot of that relates to the margin your organisation will pay. When swapped back into your natural currency, you can benefit from lower margins. One example is the basis swap enabling Kangaroo issuers to decrease their cost of funds.

Also, with the dislocation in markets post July-2007, opportunities where interest rate parity have not held up have definitely emerged. The problem is that the reason for this is that it has been relatively more difficult to borrow in one currency as opposed to another, which will make the arbitrage difficult to take advantage of.

Cheers,
Cale.

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Permalink Reply by Abhiram on June 26, 2010 at 7:06am

Lot of useful info..

Thanks a lot

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Permalink Reply by William Wun on June 21, 2010 at 4:25am

Hi all,
Theoretically speaking, the interest rates of diff

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Permalink Reply by William Wun on June 21, 2010 at 4:43am

Theoretically speaking, the interest rates of different countries are related as follows under the law of one price:

1+ r (home) / 1+ r (foreign) = 1 + p (home) / 1 + p (foreign)

That is, the differeniated interest rates across the world are caused by the differentiated exchange rates across the world. But it is too good to be true and empirically speaking, the differences in interest rates cannot wholly be explained by the law. e.g., there are many opportunities for carry-trade and the arbitrate activities cannot correct the disparaties between interest rates.

Perhaps the govenment public finance policies, a country fiscal and monetary policies, soveignty ratings, international FX speculators, a country FX policies (whether it is fixed, floating or mixed). different economic growths, international trade balances and a myriad of factors contribute to the disparaties in interest rates across the countries.

Though the law of one price can be used to predict the long run equilibrim interest rates, but the interest rate markets are vey dynamic due to "animal spirit" of the participants and quoting Keyne as saying: "in the long run, we are all dead"

William Wun

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Permalink Reply by Abhiram on June 26, 2010 at 7:09am

Very true ....

A small doubt... "Animal Spirit" would mean everyone trying to make profit out of it ?

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Permalink Reply by T.Venkataramanan on June 22, 2010 at 7:13am

definitely.take loan @cheap rates from one country and lend it @ higher rates in your country and profit

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Permalink Reply by J on June 22, 2010 at 8:20am

Can u pls reply with example

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Permalink Reply by Seth Mallamo on June 22, 2010 at 7:57am

Hedge funds profit from this trade in a big way. According to the interest rate parity theory, a currency with a higher interest rate should depreciate. This may be true in the long run, but in the short run this currency may appreciate due to funds flowing in to capitalize on the high interest being paid. This will lead to interest and capital gains for the trader. This whole situation can unwind very quickly leading to big losses, but funds can and do take advantage of this through the sale and purchase of currency futures.

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Permalink Reply by T.Venkataramanan on June 24, 2010 at 10:04pm

Investments flow where interest rates /rate of return is high.The less attractive ones devoid of interest have their natural death and in the long run equilibrium is reached .Hedge funds take advantage in the short run fluctuations and make money

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Permalink Reply by suheir sweiss on June 24, 2010 at 6:27am

cost of fund in any organization can cause the interst rate to flucuate.....

Yes arbitrage do exist..... and a person will choose the interest rate that is suitable ... whether its the lending rate or the deposit rate

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