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Authors: Brian Kettell
Published by: Centre for Islamic Banking and Finance
Published in: 1999

Abstract

This is the first of a two-case series (299-029-1 and 299-030-1). The case series is designed to illustrate the difference between how the textbooks describe the workings of the foreign exchange market with what actually takes place inside a foreign exchange dealing room. This case concentrates on the mechanism whereby covered interest arbitrage is conventionally described in the literature. In particular, it illustrates how forward exchange rates are determined from the textbook point of view. The formal textbook statement of this relationship, sometimes expressed as either interest rate parity or as covered interest rate parity comes with differing degrees of sophistication, all of which, as demonstrated in part two, is totally different from the view as seen from the inside of a foreign exchange dealing room. This case series is particularly suitable for courses where international financial markets are being studied. In particular, it is suitable for where foreign exchange hedging and arbitrage decisions are being discussed and where there is a need for an indepth understanding of how the forward market, futures market and money markets interrelate.
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Abstract

This is the first of a two-case series (299-029-1 and 299-030-1). The case series is designed to illustrate the difference between how the textbooks describe the workings of the foreign exchange market with what actually takes place inside a foreign exchange dealing room. This case concentrates on the mechanism whereby covered interest arbitrage is conventionally described in the literature. In particular, it illustrates how forward exchange rates are determined from the textbook point of view. The formal textbook statement of this relationship, sometimes expressed as either interest rate parity or as covered interest rate parity comes with differing degrees of sophistication, all of which, as demonstrated in part two, is totally different from the view as seen from the inside of a foreign exchange dealing room. This case series is particularly suitable for courses where international financial markets are being studied. In particular, it is suitable for where foreign exchange hedging and arbitrage decisions are being discussed and where there is a need for an indepth understanding of how the forward market, futures market and money markets interrelate.

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