Interest Rates and Foreign Exchange
In addition to the purchasing power approach, we can view intrinsic foreign exchange (FX) rates in terms of financial assets, particularly interest rates. This chapter introduces the role of interest rates in intrinsic FX valuation. As we said, managers need to understand when an FX rate may be misvalued. This misvaluation can be an important factor in decisions involving risk management, capital structure, and capital investment.
An intrinsic FX rate that is consistent with valuation in financial markets may be thought of as a short-run intrinsic FX rate. Note that there can simultaneously be a long-run (goods market) intrinsic spot FX rate and a short-run (financial market) intrinsic spot FX rate. ...
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