Would the interest parity condition change if all foreign exchange transactions were subject to a 1% transaction fee? If not, explain why. If yes, explain how you would drive the new interest parity condition. When would an investor prefer this type of transaction fee to one in which they paid a flat fee for each foreign exchange transaction?
Interest Parity Condition holds when the rate of return on dollar deposits is just equal to the expected rate of return on foreign deposits. Let's define:
Id = domestic interest rate of dollars
If = foreign interest rate
E = spot foreign exchange rate (dollars per foreign currency)
F = forward exchange rate (dollars per foreign currency)
Then, we consider Interest-Rate Parity first
1. the concept of equal returns
if the returns are equal on either transactions, that is, if interest-rate arbitrage has the same equalizing effect of ...
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