howdy there pack good to see y'all we're gonna talk
about interest rate parity and SS 'em one of the most powerful
techniques for fundamental analysis a forex and I
am and I this is actually a very
interesting discussion if your currency trader because it's a there's some interesting things that I
we use for currency trading in right now we got Carlos online we got
everyone Chris he only had a lot lime the way smaller on the line seaver Casey a good to see I haven't seen you
in a while and T Bone T-bone I was really good to see on the
call last night and down so we've got to you know weeks
we've got another down day on the index is but we're gonna see what happens in
terms of for it did there were some strength came in
towards the end of the day so we'll see if we get ongoing strength for tomorrow
look at that will look at the am at the many before
we close out the session tonight but i wanna get through it so hot down here in
Puerto Rico unusually hot for October and I'm I don't want to
waste time a call and down this room at the end up turning often in the in
the office and run into the better Summer Slam through this get er done and
get a rover and get to bed am so what is this stuff interest rate
parity am it's a no arbitrage condition because if interest rate parity didn't hold that
would be possible for and s2 traitor to make unlimited amounts
of money by exploiting exploiting the arbitrage opportunity but
we don't typically observed persist in arbitrage condition so weaken safely assume that interest rate
parity holds so consider an alternative one year
investment for one hundred thousand US dollars we can invest those US dollars in the
United States at the United States interest rate and
that'll give us a future value one plus the United States interest rate
times that hundred thousand dollars alter tentatively week you can trade
your dollars for pounds at the spa trade & invest one hundred
thousand dollars in Britain I'm after converting to
pounce at the British interest rate while
eliminating any exchange rate risk by sign the
future value the british investment for set these investments have exactly the
same rest they have to have the same future value otherwise arbitrage would exist and this is
exactly what interest rate parity does its it
basically ties together the am the United Kingdom II the united kingdom's economy it to
the United States economy so alternative one here is too the best one thousand dollars at the USS
trade I am alternative to is to send your
dollars on a round trip to Britain and see the process that I just walk you
through using a thousand dollars here instead out one hundred thousand
dollars because it is actually possible that you could actually do this through a british trading account there
are up companies out there I am and that will allow you to and job to pick
them got one run in the top of my mind that
at some anyway I'll remember because I had a friend of mine who is a futures
trader over Britain and I am anywhere to come to me I'm and he's just had absolutely
excellent experience with I'm but this particular brokerage over in europe they also operate in the
United States art to opened an account in Britain and also
maintain an account United States it's the easiest course if you have a
company larger trade on each side at these but the main thing is that head did if
you go and you take your dollar in you converted to
pounds and you invested in bonds over in England and then you convert that money
back in the US dollar she should have the same amount of money at the end of
the day and the pound investment that you have
in the united states com hi bond investment so and because
the out because it's all held together by
interest rate parity so the scale of the project doesn't
matter doesn't matter if it's a thousand dollars or million dollars it should all hold
together and am one interesting relationship that currency traders now it's that I am the difference between the am the d forward and the spot am that the
foreign and the and that that love a the difference
between the currency exchange rates and I am the interest rate should be
proportionate no matter how you quite the exchange
rate in terms of dollars per yeah honor yen per dollars to find the
forward rate you can increase a dollar's by the dollar rate and foreign currency
by the foreign currency rate that be really careful because it's easy to get
this wrong so I'm in fact you note the thing is
that the thing that I want to understand it the way that people get this thing wrong
usually is for instance I think it's totally acceptable two
years for instance some this I am just subtracting the two interest a rates gives you a good
approximation I've interest rate parity I'm however what I want to warn you about is
that I double frequently see people at this level and start to make assumptions that the there's a violation and pricing and
therefore there's arbitrage opportunity the problem with things like currency
trading a special one week start working to the mathematics a currency trading and the mathematics futures trading in
the mathematics Russia trading is that when we see a big difference in
price discrepancies we think that there's an arbitrage opportunity and its actually very rare that this
occurs because these markets are just literally is so incredibly official and very much
tied together heavily by the different exchange rates
from T-bone says hi Scott in team on says
okay now I have it anti but says having probs once again
with this program okay but the secular back in it and and move
ahead ham but edit but anyway be really careful because a lot of times
you may think that there's an arbitrage opportunity mean it really doesn't that
did really is not there so if you take a look at the following
set a foreign and domestic interest rates and the spot foreign exchange
rates them I'm you can use this information to
actually calculate interest rate parity in covered interest
arbitrage trader with a thousand dollars could invest in
the United States 3 percent in one year his investment will be worth I'm this amount calculated right here
which is one thousand thirty dollars alternate like that I'll alternately
this trader could exchange one thousand dollars 500 pounds at the prevailing
spot rate best 500 pounds for one year at 8 mai Sato a VM Murray okay there you go I kidded best five hundred pounds for
one year 2.48 49 percent so that the end of the
year that have 512 pounds forty-five I'm pants I am they could
translate that money back into dollars at the forward
rate and it will still be worth 1000 at thirty
dollars so this is the diagram how this particular a crash
occurs you can see her doing the exact same
thing we're running the US dollar around through the United Kingdom SCANA me and it's coming back with the exact same
amount of money now when it comes to exchange rate
determination according to them interest rate parity only 1 360 day forward rate can exist it has
to be the case for instance that if the quoted I'm town dollar pound rate a.m. is a two dollars and one said per pound then I am it has to maintain had that murderers rafters mister jerry can make my one of the
strategies so accurate I'm lost okay yeah that's fine no I'm so the trader could borrow a thousand dollars at three percent
exchange at 1500 ours at the prevailing rate invested at 2.49 percent for one year
and get 512 dollars in 45 cents the they can translate that 5 12:45 back into dollars such that it'll be
more than enough to repay their debt a thousand thirty right this is another
example love Ann Arbor trosch that for service
the interest rates to select one another and the two countries and I'm so again there here's another so here's
another example this the second arbitrage strategist mapped
out and it's the same thing as the money rolls through United Kingdom the US dollar's role to
the United Kingdom it comes back with the exact same value
regardless so it's really really important to
understand that I am that interest rate parity really does
hold the different currency markets together very tightly and if we take a look for instance at
the currency carry trade which is really interesting this is something that
professional currency traders are well aware but the currency carry trade involves
buying a currency that has a high rate of interest in finding the purchase by firing a currency with lower rates of
interest without any hedging the carry trades profitable as long as
the interest rate differentials greater than the appreciation at the funding
currency against investment currency and I'm the best example the current to
carry trade is the ozzie am and so this is the actual charted this
is the daily chart at the ozzie and you can see that it's been a crazy it's been a
pretty crazy consolidation up until I am up until the end of August and so it had
a large rise and then class to another rise since
fallen back into the channel but the main thing better standards that the funding currency is the Australian
dollar the and excuse me the investment currencies
Australian dollar and that funding currency is the Japanese yen so the Australian dollar has a very high I am interest rate that's paid on its
sovereign debt and the Japanese yen has a very low
interest rate so the currency trader actually get
sticky the spread between the low-interest paid out at the account on the Japanese yen rate compared to the which you have to much you have to pay
out on your on your funny currencies compared to the amount that's brought in
a on the investment currency and so the main thing is a scam that's a
lot like the like a dividend yield strategy in
the stock market but here you get a little bit opening a
kak to the investment as long as you're
trading only to the upside this currency pair this does not work
for shorting the ozzie and this is only only works for going long the S the ozzie a and I'm so the currency character example suppose
the one you're buying rate in dollars as 1 percent the one-year
lending rate in pounds is two and a half percent the direct spot ass exchange rate is a dollar 60 account
a traitor who borrows 1 million below 1,000,000 ten thousand and one year
trading one million for past eight spot generate 625,000 pounds 625,000 pounds investor for one year two
and a half percent ill 640,000 625 paints the current to carry trade will be
profitable the spot bit rate prevailing in one
year's high enough that his for 640,000 625 will sell for at least I am 100 and 10 house I one million ten thousand dollars
enough to repay his debt this is no less expensive then this particular activation hair the am resend so the main thing is is that on you end up
getting this additional kept but a.m. what's really very important
notices it's not a huge amount of money that that comes into the account but it's a
substantial amount if you compound that additional little
bit the money over time out over the years it can really add up
so I am so with the currency trader always
long the currency trade now there can be some potential re
deviations from interest rate parity and one reason would be that the
interest rate available to Ann Arbor treasure for borrowing make see the
reagan land that there may be bid ask spreads that have
to be overcome I capital controls can be a problem
terms a government sometimes restricting import-export money through taxes are
outright bans I am week-and-a-half transaction kasich
create problems for arbitrageurs in terms of from terms up I am it terms have actually arbitrage interest rate parity into I am
interfax this particular slight outlines that just is actually from a chapter lecture
and book report reading that's what kinda blazing throughout so on the last two slides we found and
no arbitrage and the words in his last two slides the
main thing I noticed this as we go kinda what unless you wanna had a it's
the same thing when we're rolling the two different currencies around
through the two different cut countries we end up with the exact same return as
long as interest rate parity halt if it doesn't call them were able to
make money as we go around that trap around two countries with the same batch
a mani them are able to come through that loop
with an additional bundle a cash so that's
what happens when interest rate parity doesn't halt an army that the other set the ask price
about the dead but Rick what Rick remember that this difference is
expected profit the prices on the last two slides are the prices a difference
for the customer not the dealer so that these forwarded Naz prices the
customers in different between a forward market edge in a money market the deer stands ready to be on the
opposite side I've ever trade the dealer by strong currents at the bid
price cells foreign currency the ask price browse
from a customer at lending rates the deal unless the customer post
borrowing rates that thing that's interesting about the forex markets there's no formal dealer like france
that's when we talk about the New York Stock Exchange dealers are
guys are licensed actually getting between and buy and sell inventory the Steelers
are generally the large investment banks around the world so what we know is that when we have big
shocks the liquidity like in 2007 and so forth and when like france is the money market
for froze we had we have liquidity problems and
the basic interest rate markets we also had we also had liquidity problems we have
fluctuations and liquidity at that were dramatic compared to the
normal amount of work it could liquidity that's working in the currency markets
wasn't anything necessarily that you might necessarily have noticed but but there were differences in the
quality that occurred over that period of time the dealers in different between buying
your state spot that price in buying euros in one year at the forwarded price
when interest rate parity halts so the
dealers in different between buying euros today at the spot bid price buying euros in one year at the forward
that price I'm or the forward ass price as well and so what's going on here at the idea
that there's an equilibrium where the am where the consumers a
foreign currency whether they're speculators or whether
their commercial exporters and importers I am are can are you note demanding
currency buying and selling currency and there's a dealer in between that's
that's that's making money on the spread traditionally this these dealers have
been the bank's but what are the main thing that's kinda beat like that very carefully right now in finance
years you know what happens when you have
large liquidity shocks to the system and liquidity shocks really good examples were transcends you
know when they had the bailout Fannie Mae and Freddie Mac those are
some major liquidity shocks there's a there's number by the time so we can
think up or we have liquidity shocks right I am yeah I'd terms a financial crisis
and so what we're looking at today in terms of you know modern finances to what degree I are these markets
really resilient to liquidity shocks and in Napa those are
some situations where we can actually see if there's violations to interest
rate parity when there's large fluctuations and
liquidity but what's really cool about the carry trade is that the carry trade is and this is the actual platform missus
forex trading platform right here is that the carry trade am is a it operates all the time and if this
is the daily chart if we look at the weekly chart the main
thing or the even the monthly chart we can see that there's the this that this carry trade has a
tendency to go up for very long periods of time
and that'll have a very roots very massive structural break which
happened in 2008 c 2007-2008 when we had the big I am big collapse in
the market is exactly when we had a major structural shift in terms of the carry trade but you can
see how there's this general upward bias to the carry trade and another thing that you can see about
the RTN I am cross currency pair is that it work gradually rise and then quickly break
gradually rise in that quickly break so the trick here as
a just work on getting a test purchase an
admin building a I you're building a scale once it
turns the corner starts moving back up and then a and then build the scale and
then I I'm long on that particular currency right now I've got a good trade working
on the area so I don't think at more than a few hundred dollars a brisk in
the strait in a particular point in time it's time for me to move my stops down to the next major technical level and the next major technical level years I'm right here underneath this level
right here some in a move I i'm in a move actual damages only move just slightly
above it and that a lock in some good profit on
the straight you can see that I am I've got a good amount of
profit that's worked up what happens in his currency markets as
adult randa over a long period of time and an this once gone in tonight find out ran
so it's not unusual for to drop a lot and
then pull back so I'm I'm working out and this is exactly
how a few years ago with live money actually turn about five hundred dollars
in the five thousand dollars justice this exact way and then I got away from it I started
trading work shorter terms charts and stuff then really all I do is I just I just
bomb and I just put it in just working getting up you know one
test for test purchase an and then a and I dot the position around
that so that's what I've got for you guys tonight this is actually a pretty darn cool I am talk because it gives a whole new trade
and that trade is called the carry trade and by you can see that I'm working on a
carry trade on one side at this current see
portfolio here and then on the other side of the
currency portfolio I'm in a major and the main thing to say is that I you
there's an no repetition of countries in either that
im either the numerator and the denominator this currency pair sprite the greatest
RAA Australia Day the Japan Europe and United States so what that what the reason I do that is
to reduced the correlation a in the dead as much as I can and the portfolio when
I have however poor for like this I want to diversify there's times I wanted her first divers
find there's times I doubt so that's kinda the main get there any
questions before we I hit the road and rather hear the man thanks for
making it Lewis thank you for making it at one
thank you for making it Carlos thank you for making this is yet I am L out tho hero that Spanish I'm grow back during the Spanish but I'll
leave you with that horrible thought take care i buy over now