International Fisher Effect and SOFR: Difference between pages

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This theory predicts that the spot foreign exchange (FX) rate will change over time to reflect and offset differences in interest rates in the respective currencies.  
''US interest rate benchmarks''.


So for example, unhedged currency depreciation losses will on average negate and match exactly any gains on interest differentials between the two currencies.
SOFR is the Secured Overnight Financing Rate.  


This is a broad treasuries repo financing rate, recommended as a benchmark by the Alternative Reverence Rates Committee (ARRC) of the Federal Reserve.


The International Fisher Effect links Expectations Theory in FX markets with Interest Rate Parity.
It is published by the New York Fed at approximately 8am local time.  


Interest rate parity theory predicts that forward FX rates will reflect interest rate differentials.


Expectations Theory predicts that forward FX rates will be reflected - on average - by outturn spot FX rates for the same maturities.
3 April 2018 was the first time SOFR was published. It is calculated based on actual transactions and is a volume-weighted median.  


In the first three months of the publication of SOFR the underlying overnight lending transaction volume was on average approximately USD 800 billion.


One way of speculating about this relationship is an FX ''carry trade''.  The trader speculates that the spot exchange rate will ''not'' change by as much as predicted by the International Fisher Effect.


Among other things, the International Fisher Effect suggests that it should not be possible to earn consistent profits by entering such FX carry trade speculations.
LIBOR, which is currently used as the main benchmark rate, is expected to discontinue by 2021 in light of multiple irregularities and lack of sustainability in the absence of an active underlying market.  


This is because of no-arbitrage theory, which suggests that it should not be possible to earn consistent speculative profits by speculating against Expectations Theory in any market.
SOFR is the new benchmark USD rate (alternatively known as risk-free rate) and ARRC is working with the industry to transition to SOFR from LIBOR.  




:<span style="color:#4B0082">'''Example: Emerging market currency - carry trade'''</span>
==See also==
*[[Alternative Reference Rates Committee]]
*[[Federal Reserve]]
*[[IBOR]]
*[[LIBOR]]
*[[Reference rate]]
*[[Risk-free rates]]
*[[Repo]]
*[[SOFR term rate]]
*[[SONIA]]
*[[Treasury]]


:A trader borrows a hard currency at an interest rate payable of 1% per annum.


:They invest in an emerging market currency to enjoy an interest rate receivable of 10% per annum.
===Other links===


:So long as there is no change in the exchange rate between the two currencies, the trader enjoys a gain of (approximately) 10% - 1% = 9% per annum, for as long as the carry trade is open.  Usually measured in days.
[[Media:Slaughter and May interest rate benchmarks.pdf| 2021: A Benchmark Odyssey, Practical Guidance for Treasurers on interest rate benchmarks, Slaughter and May]]


:However, the International Fisher Effect predicts that the emerging market currency will weaken against the hard currency.  By an average amount that can be calculated from the interest rate differential.
[[Category:Corporate_financial_management]]
 
 
== See also ==
* [[Carry trade]]
* [[Depreciation]]
* [[Emerging currency]]
* [[Expectations theory]]
* [[Fisher Effect]]
* [[Foreign currency]]
* [[Forward rate]]
* [[Four way equivalence model]]
* [[Hard currency]]
* [[Interest rate parity]]
* [[No arbitrage conditions]]
* [[Outturn]]
* [[Purchasing power parity]]
* [[Spot rate]]
 
[[Category:The_business_context]]
[[Category:Identify_and_assess_risks]]
[[Category:Manage_risks]]
[[Category:Cash_management]]
[[Category:Financial_products_and_markets]]
[[Category:Liquidity_management]]

Revision as of 08:04, 12 September 2021

US interest rate benchmarks.

SOFR is the Secured Overnight Financing Rate.

This is a broad treasuries repo financing rate, recommended as a benchmark by the Alternative Reverence Rates Committee (ARRC) of the Federal Reserve.

It is published by the New York Fed at approximately 8am local time.


3 April 2018 was the first time SOFR was published. It is calculated based on actual transactions and is a volume-weighted median.

In the first three months of the publication of SOFR the underlying overnight lending transaction volume was on average approximately USD 800 billion.


LIBOR, which is currently used as the main benchmark rate, is expected to discontinue by 2021 in light of multiple irregularities and lack of sustainability in the absence of an active underlying market.

SOFR is the new benchmark USD rate (alternatively known as risk-free rate) and ARRC is working with the industry to transition to SOFR from LIBOR.


See also


Other links

2021: A Benchmark Odyssey, Practical Guidance for Treasurers on interest rate benchmarks, Slaughter and May

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