1 00:00:22,630 --> 00:00:28,980 In session number 36 we will be discussing about money and forex market interaction. 2 00:00:28,980 --> 00:00:35,980 As I mentioned earlier money and forex markets are highly related to each other. Money market 3 00:00:37,660 --> 00:00:43,190 is high liquid, that takes into account the call money market, certificate deposit market, 4 00:00:43,190 --> 00:00:50,190 the commercial paper, market government, treasury bill market and forex market also as we discussed 5 00:00:51,760 --> 00:00:58,760 earlier session high liquid market the both the market. Since they are highly liquid they 6 00:00:59,239 --> 00:01:06,000 interact each other and transfer the what is called Spillovers. Spillovers means in 7 00:01:06,000 --> 00:01:12,930 the area of information, spillover from one market to another market, the volatility which 8 00:01:12,930 --> 00:01:19,900 created in one market that is in money market get transferred to the forex market and vice 9 00:01:19,900 --> 00:01:24,200 versa. So, the interaction process you should understand 10 00:01:24,200 --> 00:01:30,420 because this interaction process give rise to volatility in the spot market and also 11 00:01:30,420 --> 00:01:37,240 volatility in the money market. It may happen that the volatility transfer from one market 12 00:01:37,240 --> 00:01:42,759 to another market may be, can be checked, if you understand the nature of the volatility, 13 00:01:42,759 --> 00:01:49,069 the nature of, nature. Why the volatility is occurring because of the shortage of money 14 00:01:49,069 --> 00:01:56,069 in call market or may be highly volatile volatile forex market with the, for which the call 15 00:01:56,429 --> 00:02:02,709 money market or the near term money market are highly volatile. So, to understand the 16 00:02:02,709 --> 00:02:08,319 interactive process of money and forex market, let us do a exercise. How this two markets 17 00:02:08,319 --> 00:02:14,290 are related to each other. In this area we will be discussing about the covered interest 18 00:02:14,290 --> 00:02:20,620 parity, uncovered interest parity and also we will discuss how the forex, how the forex 19 00:02:20,620 --> 00:02:27,310 market the FI investment and the stock market related to each other. 20 00:02:27,310 --> 00:02:32,900 Whether the volatility in the stock market because of fluctuation of FII investment may 21 00:02:32,900 --> 00:02:38,640 lead to any instability money market. We will also discuss about the same thing. Let us 22 00:02:38,640 --> 00:02:45,320 start, what actually the composition of money market. As I mentioned the earlier session 23 00:02:45,320 --> 00:02:50,750 if you see the money market. Money market it is a market, having maturity over night 24 00:02:50,750 --> 00:02:57,240 to 15 days, may be less less than one year also less than one year in some other segments 25 00:02:57,240 --> 00:02:58,350 of money market. 26 00:02:58,350 --> 00:03:04,960 However, in case of call money market it is less than 14 days market. So, the money market 27 00:03:04,960 --> 00:03:10,980 having a maturity overnight, that is call money market overnight to a less than one 28 00:03:10,980 --> 00:03:15,470 year market that is treasury treasury bill, commercial papers, certificate deposits these 29 00:03:15,470 --> 00:03:22,270 are the less than one one year market. So, in the money market we have call money market 30 00:03:22,270 --> 00:03:29,270 this call money market is a purely inter-bank market because it was earlier non bank financial 31 00:03:30,020 --> 00:03:34,110 intermediary, that is the insurance insurance sector, investment banking sector they were 32 00:03:34,110 --> 00:03:41,110 the part of the money call money market, which is not now at present. Call money market purely 33 00:03:41,430 --> 00:03:46,600 inter-bank market only commercial bank participate in the call money market. 34 00:03:46,600 --> 00:03:52,300 The volatility the call money market indicates the parameter of the parameter of financial 35 00:03:52,300 --> 00:03:59,300 sector. So, because why because call money markets is the high liquid market, reflects 36 00:03:59,670 --> 00:04:05,550 the market liquidity in in market liquidity in a economy. So, the volatility the high 37 00:04:05,550 --> 00:04:11,650 interest rate call money market indicates instability in the near money market or instability 38 00:04:11,650 --> 00:04:17,509 in the money supply process. So, call money market is a highly liquid market, it is the 39 00:04:17,509 --> 00:04:24,509 it is the highly active active market in money market. Similarly, we have certificate deposit 40 00:04:24,770 --> 00:04:28,530 market. Certificate deposit market, generally 7 days 41 00:04:28,530 --> 00:04:35,530 to, 7 days maturity to one year maturity. Generally financial sector, financial institution 42 00:04:35,919 --> 00:04:41,910 they raise money through certificate deposits and financial other financial institution, 43 00:04:41,910 --> 00:04:48,910 may be trust, may be municipality corporation they participate as a as a investor in certificate 44 00:04:52,300 --> 00:04:56,830 deposit market. Similarly, institution also big financial institution, big government 45 00:04:56,830 --> 00:05:02,590 companies and private sector company they also participate in in certificate deposit 46 00:05:02,590 --> 00:05:08,060 market. They invest in certificate deposit market. Similarly, we have commercial paper 47 00:05:08,060 --> 00:05:13,720 market. Commercial paper as you know that it is a working capital requirement of financial 48 00:05:13,720 --> 00:05:19,970 your working capital requirement of manufacturing side company non financial company. 49 00:05:19,970 --> 00:05:26,970 So, they non financial company to meet their working capital requirement, they raise money 50 00:05:27,180 --> 00:05:32,570 through commercial paper, trust, financial institution they participate as a investor 51 00:05:32,570 --> 00:05:39,070 in stock investor in commercial paper. Commercial paper though it is a highly rated rated instrument, 52 00:05:39,070 --> 00:05:44,510 without rating commercial paper cannot be raised cannot be sold in Indian financial 53 00:05:44,510 --> 00:05:51,510 system. Say another segments of money market, it is the treasury bill. Treasury bill generally 54 00:05:53,590 --> 00:05:58,230 attracts a working capital requirement of government institution, government bodies, 55 00:05:58,230 --> 00:06:03,840 central government, private your central government and also municipality corporation. May be 56 00:06:03,840 --> 00:06:10,040 treasury bill also issued by financial institution that is your government body, government corporation. 57 00:06:10,040 --> 00:06:16,520 So, treasury bill that generally banks in financial institution they invest in treasury 58 00:06:16,520 --> 00:06:19,830 bill and it is the government bodies, government institution they raise treasury bill. In the 59 00:06:19,830 --> 00:06:26,280 treasury bill market also has a secondary market for treasury bill and it is a liquid 60 00:06:26,280 --> 00:06:32,160 market also. So, if you see the money market. The money market instruments are commercial 61 00:06:32,160 --> 00:06:39,070 call call money market, overnight to 14 days market. May be a certificate deposit market, 62 00:06:39,070 --> 00:06:46,070 it is a 7 days to one year market. Commercial paper market generally one year market and 63 00:06:46,350 --> 00:06:53,350 treasury bill 14 days to 365, 364 days treasury bills are available, it is also 14 days market 64 00:06:54,210 --> 00:07:00,150 to one year market. However in call money market, we have a secondary 65 00:07:00,150 --> 00:07:03,760 market. Certificate deposit market, there is no secondary market. Commercial paper market 66 00:07:03,760 --> 00:07:08,949 also rarely having secondary market, only treasury bill have a secondary market. If 67 00:07:08,949 --> 00:07:14,830 you invest the government body financial institution invest in treasury bill or this bills are 68 00:07:14,830 --> 00:07:21,590 traded in financial in our sector bill, as a secondary market in RBI windows of negotiated 69 00:07:21,590 --> 00:07:27,990 dealing system. So, only in treasury bill market in India we have a secondary market 70 00:07:27,990 --> 00:07:34,990 activity. If you see the money market, the active segments of Indian exchange market. 71 00:07:36,710 --> 00:07:43,460 If you see the fund exchange market though it is highly active. It is highly liquid market, 72 00:07:43,460 --> 00:07:48,930 but there are some segments of forex market, they are not liquid. The highly liquid in 73 00:07:48,930 --> 00:07:54,639 foreign exchange market segments are foreign exchange spot market and some extent foreign 74 00:07:54,639 --> 00:08:00,930 exchange forward market. Now, a day's foreign foreign currency options market also little 75 00:08:00,930 --> 00:08:07,840 bit liquid. However, however foreign currency spot market is highly liquid market. Then 76 00:08:07,840 --> 00:08:13,360 question arise here, which are the factor affecting foreign exchange market in India? 77 00:08:13,360 --> 00:08:18,600 So, if you see some as I mentioned earlier that money market and forex market interact 78 00:08:18,600 --> 00:08:24,490 with each other. However, the money market rate the FII inflow, 79 00:08:24,490 --> 00:08:29,530 FII outflow, the current account deficit of deficit and surplus of government of India, 80 00:08:29,530 --> 00:08:36,530 the export imports. Then industrial industrial production GDP growth, inflation, equity market 81 00:08:37,649 --> 00:08:43,519 return these are the these are the factors which actually influence the foreign exchange 82 00:08:43,519 --> 00:08:50,110 market. However, among these the FII inflow outflow, the equity market return, and the 83 00:08:50,110 --> 00:08:55,910 current account deficit and surplus generally influence the forex markets significantly. 84 00:08:55,910 --> 00:09:02,910 So, we have to understand the, nature of the alignment of this factor along with the foreign 85 00:09:03,130 --> 00:09:05,850 foreign exchange market fluctuation. 86 00:09:05,850 --> 00:09:11,020 So, when you go to when you discuss about the money market and forex market interaction 87 00:09:11,020 --> 00:09:17,950 process, we should understand that the both markets are buyers and sellers are same, almost 88 00:09:17,950 --> 00:09:23,529 same. If you see, since in the buyers and seller in money market also having a exposure 89 00:09:23,529 --> 00:09:30,529 in forex market and vice versa. So, the the since the buyers and seller the participant 90 00:09:30,850 --> 00:09:36,630 in both the marketer are same, they take position in each other market to take the to take the 91 00:09:36,630 --> 00:09:42,660 arbitrage opportunity. So, why the arbitrage opportunity occurs, it is because of the parity 92 00:09:42,660 --> 00:09:48,410 condition. So, money and foreign exchange market are interactive through the parity 93 00:09:48,410 --> 00:09:53,160 condition. So, one one determinant on, determinant of 94 00:09:53,160 --> 00:09:59,779 forward premium and discount it is influenced on exchange rate. Three important hypothesis 95 00:09:59,779 --> 00:10:06,779 has been developed because the forward premium, the forward discount of a particular exchange 96 00:10:06,970 --> 00:10:13,970 rate between INR or USA along with USD Why the USD, USD is a premium currency against 97 00:10:14,680 --> 00:10:21,680 INR? Why the INR is a discount currency against against USD, is different. On that basis we 98 00:10:22,720 --> 00:10:28,570 have a three different kind of hypothesis. Here, as we know we have discussed earlier, 99 00:10:28,570 --> 00:10:35,520 we have interest rate parity hypothesis. The hypothesis mention, first hypothesis here 100 00:10:35,520 --> 00:10:41,610 the covered interest hypothesis because the interest rate differential, it is interest 101 00:10:41,610 --> 00:10:48,610 rate differential between India and US it is is a, is related to the forward rate forward 102 00:10:50,070 --> 00:10:55,070 rate or the forward premium. The forward premium is a function of interest 103 00:10:55,070 --> 00:11:02,070 rate differential. In other word the forward the interest rate differential the amount, 104 00:11:02,350 --> 00:11:07,660 should reflect in the forward premium itself. The forward premium should bridge the gap 105 00:11:07,660 --> 00:11:13,250 of interest rate differential, if the currency though, if the if the currency is a premium 106 00:11:13,250 --> 00:11:20,100 currency, forward forward premium should reduce. If the currency is a discount currency the 107 00:11:20,100 --> 00:11:25,310 forward premium should increase. So, forward, if the forward premium reflects the interest 108 00:11:25,310 --> 00:11:30,660 rate differential then there cannot be any arbitrage opportunity. The question arise 109 00:11:30,660 --> 00:11:37,410 here, the the interest rate differential come from the money market segments of India and 110 00:11:37,410 --> 00:11:43,860 money market segments of US. Since you are discussing about India and US 111 00:11:43,860 --> 00:11:49,040 the currency exchange rate. So, if there is a money market differential interest rate 112 00:11:49,040 --> 00:11:55,529 between India and US then forward premium should bridge the gap. By bridging the gap, 113 00:11:55,529 --> 00:12:02,529 you understand that that cannot be arbitrage opportunity between Indian INR and INR and 114 00:12:02,750 --> 00:12:09,750 USD or there cannot be arbitrage arbitrage opportunity, if you travel through money market 115 00:12:11,200 --> 00:12:17,500 to forex market. So, along with the macroeconomic factor, the parity conditions decides the 116 00:12:17,500 --> 00:12:23,370 movement of exchange rate. If the interest rate differential error is there, then between 117 00:12:23,370 --> 00:12:29,260 Indian rupee interest rate differential between Indian interest rate and money market of US 118 00:12:29,260 --> 00:12:34,560 interest rate then Indian rupee will depreciate against depreciate against USD. 119 00:12:34,560 --> 00:12:40,800 Similarly, if the interest rate differential is negative, that is Indian interest rate 120 00:12:40,800 --> 00:12:47,040 is less than US interest rate, Indian currency will appreciate. So, along with the macroeconomic 121 00:12:47,040 --> 00:12:54,040 factor like the inflation IIP the current account deficit, the growth parameter, parameter 122 00:12:55,670 --> 00:13:01,820 the interest rate differential or the parity condition also decide the movement of exchange 123 00:13:01,820 --> 00:13:07,600 rate. Any deviation from the parity create arbitrage arbitrage opportunity and it will 124 00:13:07,600 --> 00:13:13,670 be reflected in the premium or discount in exchange rate. So, this parity hypothesis 125 00:13:13,670 --> 00:13:17,649 are covered interest parity. As I discussed with you uncovered interest 126 00:13:17,649 --> 00:13:23,010 parity and real interest parity. Covered interest parity mention us that interest rate differential 127 00:13:23,010 --> 00:13:27,580 should equal to the forward premium. Uncovered interest parity mention us interest rate differential 128 00:13:27,580 --> 00:13:34,580 should reflect in the change in the spot rate and real interest difference parity mention 129 00:13:36,810 --> 00:13:43,810 us that the inflation adjusted covered interest parity. So, the really interest rate differential 130 00:13:44,130 --> 00:13:50,560 should reflect in forward exchange forward premium or discount. 131 00:13:50,560 --> 00:13:56,670 When you discuss about this money market and forex markets interaction, we should also 132 00:13:56,670 --> 00:14:03,510 discuss about the international Fisher's effect. As I mentioned earlier, the international 133 00:14:03,510 --> 00:14:10,000 Fisher's effect explain that change in the current exchange rate between any two currency 134 00:14:10,000 --> 00:14:15,970 is directly proportional to the difference between these two countries nominal interest 135 00:14:15,970 --> 00:14:22,300 rate. At a particular time period the Fisher effect explain that change in the exchange 136 00:14:22,300 --> 00:14:29,040 rate between two currency is a function of nominal interest rate differential between 137 00:14:29,040 --> 00:14:35,860 two currency, two two country. Similarly, it means that percentage change in the spot 138 00:14:35,860 --> 00:14:42,860 exchange rate, over a period is the difference between nominal interest rate for the two 139 00:14:43,279 --> 00:14:48,490 currency. So, whenever there is a real interest rate 140 00:14:48,490 --> 00:14:53,390 difference is there between two currency or the nominal interest rate difference between 141 00:14:53,390 --> 00:14:58,670 the two currency, it will be reflect in the exchange rate change. Interest rate parity 142 00:14:58,670 --> 00:15:05,640 or the interest rate differential between two two countries get adjusted in forward 143 00:15:05,640 --> 00:15:12,360 rate between the currency currency of the two countries. If the interest rate differential 144 00:15:12,360 --> 00:15:19,360 reflect in forward discount or the forward premium and it will be equal, then there will 145 00:15:19,790 --> 00:15:25,209 be no arbitrage between money market and forex market. 146 00:15:25,209 --> 00:15:31,890 Similarly, interest rate differential reflect either in forward points or get adjusted in 147 00:15:31,890 --> 00:15:38,890 exchange rate itself in the form of appreciation or depreciation of currency. If the interest 148 00:15:38,899 --> 00:15:45,100 rate differential reflect in forward premium, there cannot be a arbitrage between two countries. 149 00:15:45,100 --> 00:15:52,100 Similarly, if interest rate differential reflect in either change in the spot rate, then there 150 00:15:53,000 --> 00:15:59,709 will be no difference in, no no arbitrage between forward between money market and forex 151 00:15:59,709 --> 00:16:06,389 market. So, we have to discuss these two different hypothesis, that is the covered interest parity, 152 00:16:06,389 --> 00:16:13,240 uncovered interest parity in into, in detail so, as to understand the money market and 153 00:16:13,240 --> 00:16:15,860 forex market interaction process. 154 00:16:15,860 --> 00:16:22,860 So, when I mention that call money market and forward call money market and forward 155 00:16:22,959 --> 00:16:28,050 premium should move to in a in a tandem to each other because whenever there is a call 156 00:16:28,050 --> 00:16:34,100 money increase the forward interest rate should also forward premium or discount, forward 157 00:16:34,100 --> 00:16:39,220 premium should also increase so, that that cannot be arbitrage between money market and 158 00:16:39,220 --> 00:16:46,220 forex market. If you see in Indian context, I have drawn a I have drawn a graph over the 159 00:16:46,579 --> 00:16:53,579 period 93 to 2012. Then what is the movement of movement of your call money rate? Call 160 00:16:54,300 --> 00:16:59,570 money rate is a red line, if you see and the movement of call money rate is the red line 161 00:16:59,570 --> 00:17:03,519 over the period. The call money rate over the period declining 162 00:17:03,519 --> 00:17:10,519 and remaining at around 5 percent then the green line indicate the forward premium. So, 163 00:17:11,679 --> 00:17:18,679 the forward premium all up to 2000 up to 99, 2000 it was not moving in tandem after that 164 00:17:20,569 --> 00:17:27,569 it is significantly with the movement movement in tandem with the call money rate. However, 165 00:17:27,589 --> 00:17:33,179 since there is some kind of differential exist between forward premium un call money, call 166 00:17:33,179 --> 00:17:39,150 money rate. This differential indicates some kind of arbitrage available between forex 167 00:17:39,150 --> 00:17:46,150 market and money market. However, however as compared to 93 94 to 2000 168 00:17:46,500 --> 00:17:52,740 the arbitrage opportunity between call money market and and foreign exchange market decline 169 00:17:52,740 --> 00:17:59,740 and is significantly decline over the period and remain somewhere between 1 or 2 percent 170 00:18:00,620 --> 00:18:06,650 differential. This may differential may be, may exist. However there may not be the transaction 171 00:18:06,650 --> 00:18:13,650 cost will be so much the forward the differential may may not provide any kind of arbitrage 172 00:18:13,860 --> 00:18:16,360 opportunity in real term. 173 00:18:16,360 --> 00:18:22,549 Similarly, if you see the call money rate and forward premium, forward premia and interest 174 00:18:22,549 --> 00:18:27,799 rate differential call here. Interest rate differential I mention here between call money 175 00:18:27,799 --> 00:18:33,870 rate and fed fund rate, that is fed fund is the US money market interest rate, fed fund 176 00:18:33,870 --> 00:18:37,929 rate. Then what is the difference between the fed fund rate and call money? Call money 177 00:18:37,929 --> 00:18:42,770 minus the fed fund rate I have put in one term call interest rate differential between 178 00:18:42,770 --> 00:18:49,770 India and US and here forward rate between INR and US dollar. The green line indicate 179 00:18:51,220 --> 00:18:58,220 the forward rate between INR and INR and Indian rupee Indian rupee and US dollar. 180 00:18:59,230 --> 00:19:04,250 Then the blue line indicate, the interest rate differential, the money market interest 181 00:19:04,250 --> 00:19:11,250 rate differential between India and US and these two rate should be should should almost 182 00:19:11,390 --> 00:19:18,390 remain same or almost have minute level difference should be there. So, as so, as to indicate 183 00:19:19,620 --> 00:19:25,790 no arbitrage between India, Indian Indian market and the foreign exchange Indian market 184 00:19:25,790 --> 00:19:32,790 and the US market. However, if you see the arbitrage in 93 95 up to 2000, it was quite 185 00:19:34,160 --> 00:19:41,160 high after that it reduce some extent however it is quite high in 2005, 6,7 and 9 and after 186 00:19:41,230 --> 00:19:46,980 9 the arbitrage decline little, arbitrage decline. That is the differential difference 187 00:19:46,980 --> 00:19:51,380 between forward rate interest rate differential is bridged. 188 00:19:51,380 --> 00:19:58,380 However, between 2003 to 2007, 2009 I can mention it was quite high differential and 189 00:19:59,290 --> 00:20:05,260 differential is exist because of the financial sector instability, where forward premium 190 00:20:05,260 --> 00:20:12,110 was quite high to quite high compared to the interest rate differential. So, this is because 191 00:20:12,110 --> 00:20:17,870 of uncertainty in the forex, foreign exchange market, which is the one another variable 192 00:20:17,870 --> 00:20:22,460 which may lead to may lead to high forward premium. 193 00:20:22,460 --> 00:20:29,460 If you see if you see the change in the spot rate and forward rate, I have taken here 2000 194 00:20:29,610 --> 00:20:36,610 1993 to 2012. The forward premium and the spot INR and USD exchange rates change. So, 195 00:20:37,870 --> 00:20:44,870 if you see the green line indicate the forward premium and the some that blue line indicate 196 00:20:46,350 --> 00:20:53,320 what is called the change in the spot rate between USD and INR. The INR USD spot rate 197 00:20:53,320 --> 00:20:59,669 change indicate the volatility, the volatility spot rate spot rate between India and USD 198 00:20:59,669 --> 00:21:06,669 and this volatility should be observed by the forward premium. If you see, the volatility 199 00:21:06,820 --> 00:21:13,820 though volatility is declining in, volatility is remain some extent constant in the 95 to 200 00:21:15,299 --> 00:21:20,210 2002 and forward premium also remain highly volatile during that premium. 201 00:21:20,210 --> 00:21:27,210 After to 98 remain constant and after 97 to 2002 it increase significantly and also also 202 00:21:28,660 --> 00:21:34,480 the volatility also increase significantly. The volatility of foreign exchange INR and 203 00:21:34,480 --> 00:21:39,460 USD increase forward premium also increase and this because of the instability in in 204 00:21:39,460 --> 00:21:42,140 the foreign exchange market in India. 205 00:21:42,140 --> 00:21:48,410 If you see other change in the spot interest rate differential. So, as I mentioned earlier 206 00:21:48,410 --> 00:21:53,059 the change in spot rate should be equal to the interest rate differential, if there is 207 00:21:53,059 --> 00:21:59,580 no arbitrage opportunity between money market and forex market. If differential exist, then 208 00:21:59,580 --> 00:22:05,340 there will be there will be arbitrage between two market. If I have mention here spot exchange 209 00:22:05,340 --> 00:22:12,340 rate change, spot exchange rate change is the blue line and how it is volatile over 210 00:22:13,309 --> 00:22:20,309 the year? If you see some extent less volatile from 94 to 2002, after that the 2003 onwards 211 00:22:21,200 --> 00:22:26,740 the volatility is quite increase significantly between the financial sector crisis time 2007 212 00:22:26,740 --> 00:22:32,910 and 8,9,10 it is highly volatile when between Indian rupee and USD. 213 00:22:32,910 --> 00:22:38,919 However, the interest rate differential that is a call money rate, minus the fed fund rate 214 00:22:38,919 --> 00:22:44,650 that is the interest rate. Differential between the two money markets of India and US. The 215 00:22:44,650 --> 00:22:49,210 money market differential, that is the interest rate differential also fluctuating along with 216 00:22:49,210 --> 00:22:56,210 the fluctuation of the spot and foreign exchange spot market, spot rate between Indian rupee 217 00:22:56,240 --> 00:23:02,380 and foreign, Indian rupee and USD. Though they are though they are not almost same, 218 00:23:02,380 --> 00:23:09,380 but the volatility is same between the two market. They indicate that interest rate the 219 00:23:09,620 --> 00:23:13,919 spot exchange rate volatility has transferred to the interest rate differential all money 220 00:23:13,919 --> 00:23:20,679 market. The whenever there is a volatility in the spot market, this reflect in the in 221 00:23:20,679 --> 00:23:25,679 the interest rate and further it reflect in the forward premium. So, there is a transfer 222 00:23:25,679 --> 00:23:31,160 of volatility of exchange rate volatility exchange rate to money market rate money market 223 00:23:31,160 --> 00:23:36,070 side. So, these two markets are highly volatile as the graph indicates. 224 00:23:36,070 --> 00:23:42,880 Similarly, if you see the call rate and fed fund rate. Though if the call rate and fed 225 00:23:42,880 --> 00:23:49,650 fund rate move in the same direction, same direction the volatility the arbitrage opportunity 226 00:23:49,650 --> 00:23:56,650 may be less over the year. If you see, in 93 to to 93 to 24 the rate differential is 227 00:23:57,679 --> 00:24:04,659 quite high, after that after that there is a they are moving in tandem to each other. 228 00:24:04,659 --> 00:24:10,380 Call money rate and fed fund rate, this red line indicate call money rate and the light 229 00:24:10,380 --> 00:24:16,460 pink line indicate that fed fund rate. These are also moving in tandem. However, there 230 00:24:16,460 --> 00:24:23,460 is some some some year the differential is quite high and this may this may reflect in 231 00:24:23,659 --> 00:24:30,650 spot either in exchange rate volatility between INR and USD or in the spot rate or in the 232 00:24:30,650 --> 00:24:35,169 forward rate. So, that also part of the volatility transfer 233 00:24:35,169 --> 00:24:40,159 between the call rate and forward fed fund rate to the money other segments of money 234 00:24:40,159 --> 00:24:46,030 market or to the forex market. However, the Indian rupee, Indian call money rate and the 235 00:24:46,030 --> 00:24:53,030 fed fund rate of US moving in tandem to each other. So, when you understand that the fed 236 00:24:53,080 --> 00:24:59,830 fund rate call rate interest rate differential spot INR and spot rate all are linked with 237 00:24:59,830 --> 00:25:06,140 to each other and the volatility among them the movement among them reflect the relationship 238 00:25:06,140 --> 00:25:11,510 or interaction among them then question let us find a correlation matrix among them. 239 00:25:11,510 --> 00:25:18,510 So, correlation matrix I put here. I have taken the data from 93 to 2012 monthly data 240 00:25:19,460 --> 00:25:26,460 and try to find the correlation of various segments are segments or parameters of money 241 00:25:27,000 --> 00:25:34,000 market along with the along with the exchange rate market so, as to understand the interaction 242 00:25:35,220 --> 00:25:41,230 of these two market and how these two market variables are correlate to each other. In 243 00:25:41,230 --> 00:25:47,750 this case, I have taken the call rate and fed point rate correlation. I have found the 244 00:25:47,750 --> 00:25:53,400 call rate, the Indian call money market rate and fed fund rate of US these are the two 245 00:25:53,400 --> 00:25:59,770 money market interest rate of India and US. They are some extent significantly, significant 246 00:25:59,770 --> 00:26:06,770 correlation of 0.38, though it is low some extent both are correlated to each other. 247 00:26:06,929 --> 00:26:13,049 Similarly, I have taken the call rate and interest rate differential. Here interest 248 00:26:13,049 --> 00:26:18,870 rate differential mean interest rate differential mean call rate minus the fed fund rate. Whether 249 00:26:18,870 --> 00:26:25,700 the two rates are related to each other so, I have found some extent 0.74 interest correlation, 250 00:26:25,700 --> 00:26:31,679 which is highly significant. The interest rate differential pull the call rate. So, 251 00:26:31,679 --> 00:26:35,440 call rate and positive correlation indicate whenever the interest rate differential is 252 00:26:35,440 --> 00:26:42,320 high the call rate also high. Similarly, if you see the graph, the call rate and interest 253 00:26:42,320 --> 00:26:48,840 rate differential. I have drawn a graph the call rate and interest rate differential. 254 00:26:48,840 --> 00:26:54,120 So, if you see interest rate differential indicate the forward premium and then call 255 00:26:54,120 --> 00:27:00,200 rate. Whenever the call rate is high they are moving in tandem in positive correlations 256 00:27:00,200 --> 00:27:05,669 are available among them. So, similarly I found the correlation among these two also 257 00:27:05,669 --> 00:27:12,200 moving quite high 0.74. Similarly, third correlation I have taken here, interest rate differential 258 00:27:12,200 --> 00:27:17,750 and forward premium. So, whenever interest rate differential is high, the forward premium 259 00:27:17,750 --> 00:27:24,419 should also high because interest rate differential is here call money rate minus the fed fund 260 00:27:24,419 --> 00:27:30,250 rate and forward premium should bridge the interest rate differential differential so, 261 00:27:30,250 --> 00:27:36,039 as to not having so, as to not to have any kind of arbitrage between money market and 262 00:27:36,039 --> 00:27:40,980 forex market. I found some extent what is call positive 263 00:27:40,980 --> 00:27:46,750 correlation of 0.45 between this call money interest rate differential and forward premium. 264 00:27:46,750 --> 00:27:52,590 When the contested differential is high, forward premium is also high, this indicate positive 265 00:27:52,590 --> 00:27:59,059 correlation 0.45. Similarly, I have taken interest rate differential in spot exchange 266 00:27:59,059 --> 00:28:04,090 rate. So, when interest rate differential and spot exchange rates are if you have found, 267 00:28:04,090 --> 00:28:11,090 if you want to find that correlation I found it 0.25 over the year last 15 years data. 268 00:28:11,289 --> 00:28:18,070 So, it indicate that indicate that the positive correlation indicate the, when the spot rate 269 00:28:18,070 --> 00:28:23,100 is high interest rate differential is high spot spot rate is also high. 270 00:28:23,100 --> 00:28:30,100 But however, the correlation is not so high. Here 0.25 though it is significant not so 271 00:28:31,010 --> 00:28:38,010 much. Similarly, I have found the spot exchange rate change and forward premium, the exchange 272 00:28:38,460 --> 00:28:43,539 rate volatility and forward premium. Why I mention that when exchange rate volatility 273 00:28:43,539 --> 00:28:50,380 high the forward premium should also be high, but I found a negative correlation among them. 274 00:28:50,380 --> 00:28:56,950 What is a spot exchange rate? Change spot exchange rate change, the change is positive 275 00:28:56,950 --> 00:29:02,549 or negative, the forward premium they have a negative relation. So, in case of India 276 00:29:02,549 --> 00:29:09,549 the spot exchange rate is, exchange rate change is positive and forward premium is negative. 277 00:29:11,070 --> 00:29:17,640 So, this may be a spurious correlation because theoretically it is not sound. Why it is not 278 00:29:17,640 --> 00:29:21,029 sound? When the volatility in spot exchange rate 279 00:29:21,029 --> 00:29:26,730 increase the forward premium should also increase. However, we are not finding any positive correlation 280 00:29:26,730 --> 00:29:32,580 among them, this may be a spurious correlation among these two. Similarly, call rate and 281 00:29:32,580 --> 00:29:38,360 spot exchange rate. When call spot call rate is high, there will be more flow of foreign 282 00:29:38,360 --> 00:29:45,049 exchange to India and there will be spot exchange rupee spot will decline so, I have found a 283 00:29:45,049 --> 00:29:51,830 positive correlation among them. But it is not so significant. So, 0.13 is not so high 284 00:29:51,830 --> 00:29:57,929 among the correlation among these two. So, correlation matrix indicate some extents of 285 00:29:57,929 --> 00:30:04,929 relationship between the spot spot exchange rate, forward premium, interest rate differential 286 00:30:05,200 --> 00:30:10,220 and also the forward, also the change in the spot rate. 287 00:30:10,220 --> 00:30:16,120 So, this the interest rate this correlation matrix some extent indicates that there is 288 00:30:16,120 --> 00:30:23,120 a there is relationships are significant, some extent also we have found the valid correlation 289 00:30:23,270 --> 00:30:30,270 among these variable. Let us after after going through this let us go to what is the interest 290 00:30:30,350 --> 00:30:34,580 rate parity hypotheses in case of India and US. 291 00:30:34,580 --> 00:30:41,580 Whether the interest rate parity try to give some kind of information about the interaction 292 00:30:43,270 --> 00:30:50,270 of money market and foreign exchange market. So, here I have tested the covered interest 293 00:30:50,370 --> 00:30:56,900 parity, uncovered interest parity and try to find the deviation of spot deviation of 294 00:30:56,900 --> 00:31:02,980 this parity. Where the deviation occurs? The deviation may be because of high transaction 295 00:31:02,980 --> 00:31:09,980 cost, expectation of the participant, the inefficient market may be because of the control 296 00:31:10,210 --> 00:31:16,610 on money capital movement. If the both market are interactive to each other, both there 297 00:31:16,610 --> 00:31:23,610 is no no such kind of barrier between these two money and forex market. Then or the movement 298 00:31:26,240 --> 00:31:32,049 of foreign currency, the arbitrage opportunity will least in this two market. 299 00:31:32,049 --> 00:31:38,350 If the covered interest parity or the uncovered interest parity holds in India or the abide 300 00:31:38,350 --> 00:31:43,940 market are abide by these two interest rate parity, there cannot be arbitrage opportunity. 301 00:31:43,940 --> 00:31:50,940 If there is a arbitrage opportunity is there, then it may because of movement control in 302 00:31:51,200 --> 00:31:56,919 capital movement, the markets are inefficient, the transaction costs are very high or there 303 00:31:56,919 --> 00:32:03,080 are may be expectation on the part of the participant in the financial market. So, what 304 00:32:03,080 --> 00:32:09,190 actually covered interest parity reflect to us a reveals to us? The covered interest parity 305 00:32:09,190 --> 00:32:16,130 as I mentioned earlier the forward premium is a function of interest rate differential. 306 00:32:16,130 --> 00:32:23,120 The forward premium should decide its value decides its value as per the movement of interest 307 00:32:23,120 --> 00:32:29,029 rate differential between two money markets. That is money market of India or and money 308 00:32:29,029 --> 00:32:36,029 market of US. In case of we are deciding about the forward premium between USD in India and 309 00:32:36,590 --> 00:32:43,590 US. Similarly, the uncovered interest parity reveals us that expected change in spot rate 310 00:32:43,730 --> 00:32:50,610 after suppose, after one period what should be change in spot rate and how much spot rate 311 00:32:50,610 --> 00:32:55,350 should change it depends upon, how much interest rate differentials are there between money 312 00:32:55,350 --> 00:33:01,669 market of US and money market of India. If the covered interest parity, uncovered interest 313 00:33:01,669 --> 00:33:08,669 parity holds in India, then there are, may cannot be arbitrage opportunity between money 314 00:33:08,669 --> 00:33:13,059 market and forex market. Let us go test this covered interest parity, 315 00:33:13,059 --> 00:33:20,059 uncovered interest parity in case of India and US and try to find whether the interest 316 00:33:21,029 --> 00:33:28,029 rate parity holds in case of India. If it there is, if the if they, if it is not there 317 00:33:30,809 --> 00:33:35,830 then question is what is the deviations? How much deviations are there between a interest 318 00:33:35,830 --> 00:33:37,169 rate parity? 319 00:33:37,169 --> 00:33:43,429 Let us, for this reason what I have done here I have taken into account the last 1993 to 320 00:33:43,429 --> 00:33:50,429 2012 data monthly data of what is called that your forward premium as a dependant variable. 321 00:33:54,470 --> 00:34:00,770 Also I have taken the interest differential between call money market and fed fund rate 322 00:34:00,770 --> 00:34:06,309 and try to find as a correlation and what is called ordinary least square. I put the 323 00:34:06,309 --> 00:34:13,309 ordinary least square and try to find whether the forward premium which is a dependant variable 324 00:34:13,579 --> 00:34:19,970 is a function of interest rate differential. So, here the least square, ordinary least 325 00:34:19,970 --> 00:34:26,730 square reveals that, the here if you see the dependent variable is forward premium. 326 00:34:26,730 --> 00:34:33,730 It is a different variable is forward premia and independent variable is a constant and 327 00:34:34,089 --> 00:34:40,249 interest rate differential. So, after running the regression, ordinary least squares I run 328 00:34:40,249 --> 00:34:45,639 it and I found that the equation is the forward the beta coefficient or the slope coefficient 329 00:34:45,639 --> 00:34:52,639 of is interest rate differential is a minus 0.294706, which is significant which is significant 330 00:34:58,160 --> 00:35:05,160 statistically significant and constant is also statistically significant and these two, 331 00:35:06,019 --> 00:35:13,019 this equation is best fit Durbin Watson. If you see almost 1.80 quite high, in some extent 332 00:35:14,420 --> 00:35:21,069 it is supposed to be two, but it is around moving towards two that is, the if you see 333 00:35:21,069 --> 00:35:28,069 adjusted R square is 0.80 is quite high and the model testing is also valid model testing 334 00:35:28,920 --> 00:35:32,579 is also valid. If you see the F value the model testing is 335 00:35:32,579 --> 00:35:39,180 also also valid. So, this equation is valid equation the coefficient is significant the 336 00:35:39,180 --> 00:35:43,309 interest rate differential coefficient is significant. So, this indicate the equation 337 00:35:43,309 --> 00:35:50,309 is significant model is valid. However, however the forward premium is a negative function 338 00:35:51,279 --> 00:35:56,640 of interest rate differential. It means that forward premium is declining with the rising 339 00:35:56,640 --> 00:36:03,140 interest rate differential. The interest differential increases forward premium is declining. So, 340 00:36:03,140 --> 00:36:10,140 that is the negative slope indicate however, if whether whether the CIP hypotheses is valid. 341 00:36:12,569 --> 00:36:18,430 CIP hypotheses is valid,, when the interest rate if you see the plotted the actuals and 342 00:36:18,430 --> 00:36:25,430 the actuals of the forward premium along with the estimated of the forward premium. I estimate 343 00:36:25,969 --> 00:36:31,940 from this equation, every year I can estimate the forward premium and every year forward 344 00:36:31,940 --> 00:36:38,940 premium data also I have that is actual data and plot this to equation the red line indicate 345 00:36:41,529 --> 00:36:42,329 the actual actual forward premium. 346 00:36:42,329 --> 00:36:48,249 What I have data set I have with me and the blue line indicate as per the regression equation 347 00:36:48,249 --> 00:36:54,459 what is the predicted line the predicted line is here, fitted line is here. If you see 93 348 00:36:54,459 --> 00:37:01,459 to 2000 98 99. Up to 2000, I can say 2002 the differential is quite high. That is means 349 00:37:04,749 --> 00:37:10,900 forward interest parity it does not hold in India, at the same time also the interest 350 00:37:10,900 --> 00:37:16,380 rate was interest rate is the differentially deviation from the parity also quite high. 351 00:37:16,380 --> 00:37:23,380 After 2002 the parity condition the deviation decline and after 2007, I can 2007 8 the parity 352 00:37:27,579 --> 00:37:32,759 deviation quite high because of the financial sector instability. 353 00:37:32,759 --> 00:37:39,509 This indicate that though the deviation of from the parity is there, the deviation is 354 00:37:39,509 --> 00:37:45,249 declining over the year means Indian market and the US market moving in tandem to reduce 355 00:37:45,249 --> 00:37:52,249 the arbitrage opportunity between forex market and the money market. However, the interest 356 00:37:52,430 --> 00:37:57,660 rate differential or the covered interest parity does not hold in case of India and 357 00:37:57,660 --> 00:38:02,469 there is deviation is still there, the deviation though it is declining over the year. The 358 00:38:02,469 --> 00:38:07,950 question I mentioned earlier to you, the deviation is because of the capital control, we do not 359 00:38:07,950 --> 00:38:13,549 have complete capital account convertibility. We have a transaction cost is quite high. 360 00:38:13,549 --> 00:38:18,839 If you move from money market to forex market and forex market to money market, you have 361 00:38:18,839 --> 00:38:24,979 to pay a transaction cost. The transaction cost also indicate, the deviation is there 362 00:38:24,979 --> 00:38:31,979 should be there between two market to remove the arbitrage opportunity. If the adjusted 363 00:38:32,739 --> 00:38:36,839 arbitrage opportunity you can calculate, that we adjusted through transaction cost a deviation 364 00:38:36,839 --> 00:38:38,709 may further reduce also. 365 00:38:38,709 --> 00:38:44,229 It is same same thing I have tested uncovered interest parity. Here uncovered interest parity 366 00:38:44,229 --> 00:38:50,739 if you see, the in dependent variable is a spot change. Spot exchange rate change between 367 00:38:50,739 --> 00:38:56,759 Indian rupee and US dollar. It should be a function of interest rate, differential the 368 00:38:56,759 --> 00:39:01,059 interest rate. Differential how much spot should change how much interest rate differentials 369 00:39:01,059 --> 00:39:06,069 are available. If they two are same, there cannot be arbitrage opportunity between money 370 00:39:06,069 --> 00:39:13,069 market and spot money market and forex market. I run the regression from 93 to 2012 and I 371 00:39:13,799 --> 00:39:18,349 found the spot exchange rate change is a function of interest rate differential. So, the interest 372 00:39:18,349 --> 00:39:23,619 rate differential equation, if you see it is not a valid regression equation. 373 00:39:23,619 --> 00:39:30,619 Though the model is though the model is not significant, the adjusted R square is quite 374 00:39:31,999 --> 00:39:38,039 low and the regression equation is not a valid regression equation. So, uncovered interest 375 00:39:38,039 --> 00:39:40,499 parity cannot be tested in case of India. 376 00:39:40,499 --> 00:39:45,400 However, if you see the deviation between actual and fitted, they are also highly fluctuating. 377 00:39:45,400 --> 00:39:51,920 A green line the the blue line is fitted line and the green, the red line is a actual line 378 00:39:51,920 --> 00:39:57,019 highly fluctuating. Then, the model is not describing anything about the interest rate 379 00:39:57,019 --> 00:40:03,249 differential and and the spot exchange rate trend or the uncovered interest parity. So, 380 00:40:03,249 --> 00:40:09,420 this model is not a valid model. It may also you can also, go for some other kind of data 381 00:40:09,420 --> 00:40:16,420 adjustment to find a valid model for that. Then if you say that I what what we have discussed 382 00:40:17,029 --> 00:40:21,839 so far. You have taken into account the money market and forex market interaction process. 383 00:40:21,839 --> 00:40:27,369 However, we have found that some extent the both market are interacted to each other and 384 00:40:27,369 --> 00:40:33,529 some extent the deviation between the two market is declining and forex market and money 385 00:40:33,529 --> 00:40:40,079 market moving in tandem. There may be some extent integration also there, but still deviation 386 00:40:40,079 --> 00:40:46,190 is still there and deviation is because of the high transaction cost control in the capital 387 00:40:46,190 --> 00:40:52,299 movement and also the deviation over the year declining. Since, because of the financial 388 00:40:52,299 --> 00:40:59,299 sector reform measure. However, we have confined our self to interest rate, but foreign exchange 389 00:41:00,259 --> 00:41:07,259 market also influence because of the FII inflow. When the FIIs because after 93, 94 onwards 390 00:41:07,789 --> 00:41:11,469 we have implemented what is called financial sector reform measure. 391 00:41:11,469 --> 00:41:16,949 We have reduced the, we have allowed the FII FII that is foreign institutional investor, 392 00:41:16,949 --> 00:41:23,219 to invest in our stock market invest. In our bond market and some extent the FII inflow 393 00:41:23,219 --> 00:41:30,219 to foreign exchange the FII inflow to our equity market has lead to the some kind of 394 00:41:31,729 --> 00:41:37,839 some kind of adjustment in the spot exchange rate. Whether the spot exchange rate have 395 00:41:37,839 --> 00:41:44,839 any kind of relationship between the BSE sensitive index return, whether the index return influence, 396 00:41:46,969 --> 00:41:53,969 the index return influence the spot exchange rate whether there is a relationship between 397 00:41:54,359 --> 00:42:01,359 the BSE sensitive index and also with that of what is called the foreign exchange market 398 00:42:05,829 --> 00:42:11,759 because FII inflow lead to appreciation or depreciation of rupee which may also reflect 399 00:42:11,759 --> 00:42:16,979 in forward rate agreement, forward rate premium discount of forward rate. 400 00:42:16,979 --> 00:42:23,979 So, the forward rate the FII inflow the in BSE BSE index return and the spot exchange 401 00:42:25,749 --> 00:42:30,209 return rate may be some kind of relationship will be there. Let us find the relationship 402 00:42:30,209 --> 00:42:35,589 whether it is available in case of India the relation is valid in case of India. Whether 403 00:42:35,589 --> 00:42:41,779 you can modify the interest rate hypotheses that is in covered interest hypotheses, uncovered 404 00:42:41,779 --> 00:42:48,779 interest hypotheses through the BSE return index. Let us do a some kind of analysis in 405 00:42:49,019 --> 00:42:49,680 this area. 406 00:42:49,680 --> 00:42:56,680 So, we I have drawn a graph here taking into account BSE return, BSE index return and fed 407 00:42:57,809 --> 00:43:04,809 fund rate. Whether there is a relation among this the BSE return BSE return is in in the 408 00:43:06,319 --> 00:43:12,859 blue line. The BSE return some extent 93 to 2012 some extent two three percent there. 409 00:43:12,859 --> 00:43:19,859 Over the year and whether whether the forward premium is green line, how it is fluctuating 410 00:43:21,549 --> 00:43:28,549 and the fed fund rate is the red line. So, fed fund rate and we looking at the graph 411 00:43:30,170 --> 00:43:35,199 we cannot decide so, there is any kind any kind of relations among them. The graph long 412 00:43:35,199 --> 00:43:41,940 run tendency is there both are declining and tendency is that both are moving in long run 413 00:43:41,940 --> 00:43:47,119 with a declining trend. However, there is no such kind of pattern relationship pattern 414 00:43:47,119 --> 00:43:51,670 of change it does not reflect does not reflect here. 415 00:43:51,670 --> 00:43:58,670 However, if you some extent go further, bifurcation whether the forward premium a return deferential. 416 00:43:58,920 --> 00:44:05,249 Here return differential I have taken so, the return differential and forward premium 417 00:44:05,249 --> 00:44:11,539 some extent relations is there. Because FIIs are coming to India they are investing in 418 00:44:11,539 --> 00:44:18,539 stock market and the movement of stock market, the return of the stock market influence the 419 00:44:18,809 --> 00:44:25,809 or pulls the FII to Indian market. Indian Indian BSE or the NSE giving good return, 420 00:44:27,410 --> 00:44:33,819 FII will invest there and with the FII the foreign exchange will come to India. Rupee 421 00:44:33,819 --> 00:44:39,670 will depreciate or appreciate depends upon the flow. Appreciation or depreciation or 422 00:44:39,670 --> 00:44:45,390 volatility of rupee reflect in forward rate forward premium or discount. 423 00:44:45,390 --> 00:44:52,390 So, whether this kind of relations are there, if you see the BSE return differential between 424 00:44:54,680 --> 00:45:01,680 the your fed fund rate and the BSE index it is fluctuating and some extent also forward 425 00:45:02,380 --> 00:45:07,130 premium also fluctuating. So, interest rate differential will highly fluctuate forward 426 00:45:07,130 --> 00:45:12,680 premium also moving outwards. So, whenever there is a decline in return forward premium 427 00:45:12,680 --> 00:45:18,009 is declining the when may be increased return forward premium is increasing. So, with the 428 00:45:18,009 --> 00:45:25,009 rising in rising in return from the forex your BSE index, rising return in the equity 429 00:45:25,349 --> 00:45:32,349 market pulls forward pulls your FII to India. FII will come to India looking at the high, 430 00:45:32,380 --> 00:45:39,229 in high return in the in the BSE index and when they bring more foreign exchange to India 431 00:45:39,229 --> 00:45:45,009 the rupee will appreciate or depreciate because of the movement of FII and the appreciation 432 00:45:45,009 --> 00:45:50,380 depreciation. Create some volatility in the spot market when the volatility is high forward 433 00:45:50,380 --> 00:45:55,709 rate will be forward premium or discount will be also high. So, that is a relationship among 434 00:45:55,709 --> 00:46:01,539 these two markets and these two markets are moving in tandem, the graph indicates two 435 00:46:01,539 --> 00:46:03,190 markets are moving in tandem. 436 00:46:03,190 --> 00:46:10,190 Similarly, I have drawn a INR spot change. A return differential when return differential 437 00:46:10,640 --> 00:46:16,940 that is equity market is giving more return, there will be more FII in in equity market 438 00:46:16,940 --> 00:46:22,729 and this FII when comes to India there will be fluctuation in INR and spot INR and rupee 439 00:46:22,729 --> 00:46:29,729 rate INR and USD rate and the INR rupee INR and USD fluctuation, may reflect in return 440 00:46:32,799 --> 00:46:39,799 return differential. So, I have drawn a two two graph between between the INR INR and 441 00:46:40,199 --> 00:46:47,170 USD and return differential. I have found the return differential is highly highly remained 442 00:46:47,170 --> 00:46:53,650 stable over the year last 13 last 12 ,13 years, some extent 4 to 5 percent fifth percent. 443 00:46:53,650 --> 00:46:59,680 However, the return differential is fluctuating. This indicate that, the instability instability 444 00:46:59,680 --> 00:47:06,680 in the BSE market or the equity market leads to fluctuation of FII inflow. When the rupee 445 00:47:08,539 --> 00:47:14,539 when the fluctuations are there in the FII inflow it reflects in the spot exchange rate 446 00:47:14,539 --> 00:47:17,509 change and this change leads to the forward premium volatility. 447 00:47:17,509 --> 00:47:24,509 So, similarly, I have done another graph try to find the INR spot change return differential 448 00:47:25,459 --> 00:47:32,459 in FII change, FII inflow. So, if you see the green line indicate green line indicate 449 00:47:34,779 --> 00:47:41,039 FII change FII inflow changing, what is the percentage change FII inflow every year? The 450 00:47:41,039 --> 00:47:46,910 red line indicates return differential between a BSE and the forward your fed fund rate. 451 00:47:46,910 --> 00:47:53,910 These two are moving in tandem so, more when the return differential and FII are moving 452 00:47:55,630 --> 00:48:01,910 in tandem. They have a they are highly correlated and the FII fluctuation of FII investment 453 00:48:01,910 --> 00:48:08,910 in in Indian stock market giving a volatility in Indian spot exchange rate between the USD 454 00:48:10,079 --> 00:48:15,329 and INR. This indicates that, these three are highly correlated and some extent they 455 00:48:15,329 --> 00:48:22,329 are moving in in a one direction. The direction is nothing but FII inflow, return differential 456 00:48:23,259 --> 00:48:29,140 in case of changing and changing in the spot rate this relationship among them. 457 00:48:29,140 --> 00:48:36,140 So, I try to find the correlation among these two, among this three and found that FII investment 458 00:48:36,430 --> 00:48:43,430 and BSE return they are highly correlated, 0.835. When FII investment in BSE return is 459 00:48:45,930 --> 00:48:51,420 increasing more FIIs are coming to India and they are highly correlated positive correlation 460 00:48:51,420 --> 00:48:58,420 0.836 0.835 indicate the FII inflow and BSE is a BSE return are highly correlated. Similarly, 461 00:48:58,420 --> 00:49:05,420 I have found BSE return and INR USD change. So, BSE return is declining the fluctuation 462 00:49:07,259 --> 00:49:14,259 of INR and spot they INR and USD spot, the fluctuation and BSE index they are negatively 463 00:49:18,529 --> 00:49:24,749 correlated. The BSE return is declining, INR is highly fluctuate, BSE return is increasing 464 00:49:24,749 --> 00:49:31,749 INR is INR is spot is declining. There also negative correlation 0.64 indicates 465 00:49:33,319 --> 00:49:38,969 that some extent a relationships are there, these two between these two variables . Similarly, 466 00:49:38,969 --> 00:49:45,819 I have found BSE return and fed fund rate differential and forward rate. The return 467 00:49:45,819 --> 00:49:51,739 differential between BSE return minus fed fund rate and the forward rate so, whether 468 00:49:51,739 --> 00:49:57,900 the forward premium or discount is because and the return differential are correlated. 469 00:49:57,900 --> 00:50:03,849 Though I found some extent correlation among these two, but the correlation is around 0.244 470 00:50:03,849 --> 00:50:10,849 percent. So, both are positively correlated, but not so not so high so there are there 471 00:50:11,609 --> 00:50:18,189 is, there are some some some degree of relationship between FII inflow BSE return, spot exchange 472 00:50:18,189 --> 00:50:24,799 rate change and the return forward market forward rate or forward forward premium or 473 00:50:24,799 --> 00:50:30,949 forward discount. All these four variables are having some extent of correlation. 474 00:50:30,949 --> 00:50:37,559 I tried to find the what is the interest rate parity hypotheses here. In place of interest 475 00:50:37,559 --> 00:50:44,559 rate I have taken BSE rate, BSE return. So, our return differential whether the covered 476 00:50:45,779 --> 00:50:51,249 covered return parity. Now, a days it a parity interest parity nobody is using, they are 477 00:50:51,249 --> 00:50:56,170 using because FIIs or foreign exchanges are coming to India primarily because of return 478 00:50:56,170 --> 00:51:03,170 in available in stock market. So, return differential is equal to forward premium. So, forward premia 479 00:51:04,509 --> 00:51:11,509 is reflected through return differential. Forward premia is reflected through the interest 480 00:51:11,640 --> 00:51:16,390 in return differential I found here a forward premia is a function rate in differential 481 00:51:16,390 --> 00:51:21,660 to try to find the covered interest covered interest parity. The return differential available 482 00:51:21,660 --> 00:51:27,579 between BSE return and the fed fund rate so will be reflected in the forward premia. 483 00:51:27,579 --> 00:51:33,959 Similarly, uncovered interest parity the change in the spot rate between INR and USD should 484 00:51:33,959 --> 00:51:40,499 be a function of return differential. How much INR and USD should change in the spot 485 00:51:40,499 --> 00:51:45,839 market. How much interest rate differential are available if these two are abide by in 486 00:51:45,839 --> 00:51:52,839 abide in by the market in India then there cannot be arbitrage opportunity. However, 487 00:51:53,449 --> 00:51:58,609 however this may not be true in case of India since, the arbitrage opportunity definitely 488 00:51:58,609 --> 00:52:02,180 will be available. Let us test these two hypotheses. 489 00:52:02,180 --> 00:52:07,380 Similarly, I have done the OLS regression. I have found covered interest parity hypotheses 490 00:52:07,380 --> 00:52:12,880 covered rate return parity. Then I have taken forward premia as a dependent variable which 491 00:52:12,880 --> 00:52:19,599 is function of return differential. I have found it is not abide in India. So, return 492 00:52:19,599 --> 00:52:26,599 differential is not deciding return differential is not deciding the covered in forward premia 493 00:52:27,479 --> 00:52:28,509 in India. 494 00:52:28,509 --> 00:52:34,499 Similarly, uncovered interest parity deviation. If you see the deviation between the forward 495 00:52:34,499 --> 00:52:41,239 premia a interest rate from the covered covered rate parity, the green line indicate the fitted 496 00:52:41,239 --> 00:52:48,239 line, a blue line indicate the fitted line and red line indicate the actual line. There 497 00:52:48,249 --> 00:52:55,059 is no such kind of relationship among these two so, forward premia is not decide decided 498 00:52:55,059 --> 00:53:02,059 by the BSE return differential between BSE and fed fund rate. So, they are to independent 499 00:53:02,529 --> 00:53:03,069 variables. 500 00:53:03,069 --> 00:53:09,189 Similarly, I have run the uncovered uncovered rate parity. Here the dependent variable is 501 00:53:09,189 --> 00:53:16,189 INR spot change and independent variable is your return differential. So, the return differential 502 00:53:16,269 --> 00:53:23,239 deciding the INR spot change this also does not hold in case of India and there is no 503 00:53:23,239 --> 00:53:24,959 relationship these two variable. 504 00:53:24,959 --> 00:53:31,079 So and the graph also telling there is no relationship. The actually is fluctuating 505 00:53:31,079 --> 00:53:35,809 actual red line is highly fluctuating, blue line nowhere deciding the a red line. So, 506 00:53:35,809 --> 00:53:42,809 there is no difference, there is also here no the return differential, not reflecting 507 00:53:46,279 --> 00:53:51,859 the forward premium. So, that though FIIs are flowing coming to India, they are influencing 508 00:53:51,859 --> 00:53:58,069 the BSE return and NSE return they are also influencing the spot rate, but nowhere the 509 00:53:58,069 --> 00:54:05,069 forward premia or spot rate is highly dependent upon the return upon the return of the BSE 510 00:54:09,670 --> 00:54:15,819 or NSE in Indian cash. So, along these let me conclude that there are maybe there is 511 00:54:15,819 --> 00:54:22,599 some kind of relationship in Indian context between money market and forex market. Money 512 00:54:22,599 --> 00:54:29,599 market rate particularly the call money rate and the forward premium is highly highly dependent 513 00:54:30,219 --> 00:54:34,109 to each other. They are interdependent and forex market, 514 00:54:34,109 --> 00:54:41,109 that is a spot market and forward market forex market, have some kind of relationship with 515 00:54:42,339 --> 00:54:49,339 the call money rate. However, the FIi inflow which influencing the BSE or NSE return equity 516 00:54:50,910 --> 00:54:57,910 market return, not deciding the forward premium and not deciding the spot market also spot 517 00:54:58,609 --> 00:55:05,609 market of INR and USD. So, though interest rate parity some extent available in India, 518 00:55:06,329 --> 00:55:11,719 it does not hold however over the year covered their interest rate the deviation from interest 519 00:55:11,719 --> 00:55:18,719 rate parity is declining. However, it is not so in case of return parity, where return 520 00:55:19,239 --> 00:55:24,599 is the BSE or NSE NSE equity market. So, with this let me conclude this. Some model question 521 00:55:24,599 --> 00:55:26,439 I have designed for you. 522 00:55:26,439 --> 00:55:33,410 So, it is like that while defining the parity hypothesis outline various theories of interest 523 00:55:33,410 --> 00:55:39,829 rate parity. So, you have to mention what is parity hypothesis here and try to differentiate 524 00:55:39,829 --> 00:55:45,189 the covered interest parity uncovered interest parity and real interest parity. How they 525 00:55:45,189 --> 00:55:51,819 are different from each other and here you have to mention that in in a parity hypothesis. 526 00:55:51,819 --> 00:55:58,819 Try to address the relationship between interest rate differential and the forward forward 527 00:55:58,829 --> 00:56:04,179 premium or discount and try to at reflect the relationship between the money market 528 00:56:04,179 --> 00:56:09,819 and forex market. Covered interest parity reflect the forward premium should be equal 529 00:56:09,819 --> 00:56:15,949 to the interest rate differential, uncovered interest parity reflect that the forward premium 530 00:56:15,949 --> 00:56:22,349 should decide the fluctuation of the spot market. Real interest parity try to address 531 00:56:22,349 --> 00:56:28,809 the issue of inflation or the nominal and real interest rate, how they are linked to 532 00:56:28,809 --> 00:56:34,400 forward forward premium and discount. Second question is here, bring out the relationship 533 00:56:34,400 --> 00:56:39,439 between money and forex market? You will have to find out the various instrument of money 534 00:56:39,439 --> 00:56:45,219 market. You have to find out the various instrument of forex market. How these two markets are 535 00:56:45,219 --> 00:56:50,459 related to each other? How what is the movement of these parameters two markets parameters 536 00:56:50,459 --> 00:56:55,819 variable and how they reflect the relationship among them we have discussed in detail these 537 00:56:55,819 --> 00:57:01,529 two cases. Similarly third question is, describe the reason of deviation from interest rate 538 00:57:01,529 --> 00:57:07,429 parity in the Indian context. You have to discuss here, why are the deviation occurs 539 00:57:07,429 --> 00:57:12,689 between interest rate parity? The because interest the arbitrage available between two 540 00:57:12,689 --> 00:57:16,589 market, the arbitrage available why the arbitrage are there. 541 00:57:16,589 --> 00:57:21,789 The arbitrage may be because of in lack of information, the arbitrage may be because 542 00:57:21,789 --> 00:57:27,119 of transaction cost, the arbitrage may be because of the control of capital movement, 543 00:57:27,119 --> 00:57:34,119 you have to address all these issue and try to find out if there is an other reasons of 544 00:57:34,329 --> 00:57:39,229 not holding of interest rate parity hypothesis in case of India because it may be because 545 00:57:39,229 --> 00:57:45,670 of expectation of participant in the foreign exchange market, it may be lack of information. 546 00:57:45,670 --> 00:57:52,229 So, all these thing you discuss in the third question and find try to find the reason, 547 00:57:52,229 --> 00:57:57,059 why a deviation interest rate parity does not hold in case of India. 548 00:57:57,059 --> 00:57:57,979 Thank you.