The Advanced Premium Paradox in Monetary Markets

BFM208 - International Finance online exam

Contents
MAIN BODY..............................................................................................................................................3
Question 1...............................................................................................................................................3
Question 2...............................................................................................................................................5
REFERENCES............................................................................................................................................9

MAIN BODY
Question 1
The advanced premium paradox in monetary markets (also known as the Fama puzzle) relates to
the well analytical observation that national interest rates surpass international interest rates
while the local nominal ratings are estimated to be appreciated (Moran and Nono, 2018). The
theory assumes that if all the currencies were to be similarly volatile, shareholders will seek
higher interest rate levels on the currency that are anticipated to be of value. The theory is that, in
the event that they all are relatively sure, shareholders will demand higher inflation on currency.
The initial value puzzle is closely linked in the absence of exposed parity and the process of pre-
rate distortion. The puzzle is that the advance premium generally points in the opposite direction
in the spot price for the ex post movement. Discovered disparity of interest implies that forward
discount and thus the interest difference can be an impartial indicator of the ex post spot rate
adjustment, if covered disparity of interest occurs, implying realistic expectations. The puzzle of
the forward rate skew is that the forward rate does not give an uneven estimate of the potential
spot rate. To determine concepts and conditions, specify the advance rates at time s to be
included in a transaction k as Ft and the exchange rates t as St. In addition, the subjective
anticipation of the time spot rates t+k is defined as St+k ć depending on length t knowledge.
Assuming realistic expectations for the moment, viz.,) (And St+k).
Factors that have been included to explain its existence
Interest rates- With the rise in interest rates, higher mortgage payments are made from keeping
this nation's currency, providing more benefit growth prospects. The price of the tax obligations
among traders who want to buy this. Conversely, once the premiums fall, profit options are
deemed less desirable and the money is used, which causes individuals to want to sell. The price
of the currency declines with rising requests.
Economic stability- A stable economy, attracted by external investment, is seen as a low risk.
The cost of its currency is increased by this demand (Reed IV, 2019). In comparison, a weaker
economy causes investors to lose confidence and withdraw deposits, resulting in a decline in the
currency.