Risk-Neutral Valuation and Interest Rate Parity
- Risk Management
The risk-neutral valuation notes use a pricing measure under which discounted tradable prices are martingales. The expected payoff is discounted at the funding rate rather than forecast under the physical return distribution.
For foreign exchange, the same replication logic gives interest-rate parity. If domestic and foreign money-market accounts are both available, the forward exchange rate must balance their growth rates; otherwise borrowing in one currency and lending in the other creates an arbitrage.
The class treats parity as a control check. A quoted forward, spot, and pair of rates should agree after day-count, compounding, and collateral conventions are made explicit.