What is Interest Rate Parity?
Hey everyone, Do you know What is Interest Rate Parity? If not, then don’t worry, today I had written on Interest Rate Parity. In our previous post we have discussed about Brexit, Introduction on Stock Market & Other matters.
Interest Rate Parity is a theory in which interest rate difference between two countries is equal to the difference between the spot exchange rate and forward exchange rate . These include spot rates , interest rates , forward rates .
Interest rate parity ensures that there will be no arbitrage in foreign exchange market . So that the investor could not lock in the current exchange rate in one currency for a lower price and then purchase another currency from a country which is offering high interest rate.It establishes the break even condition where the return from the investment made in domestic currency Is identical to the return from the investment made in foreign currency covered against foreign exchange risk.
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Covered & Uncovered Interest Rate Parity:
The main thing in the interest rate parity is to prevent from arbitrage profit .The interest rate parity is said to be covered when no arbitrage condition is satisfied through the forward contract in order to hedge from the foreign exchange risk. The uncovered interest rate parity does not invlove forward contract for no arbitrage condition .
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-Prakrati Jindal (Team Itslyf)