A parity condition stating that the difference in interest rates between two countries is equal to the expected change in exchange rates between the countries’ currencies. If this parity does not exist, there is an opportunity to make a profit.
"i1" represents the interest rate of country 1
"i2" represents the interest rate of country 2
"E(e)" represents the expected rate of change in the exchange rate
Investopedia Says:
For example, assume that the interest rate in America is 10% and the interest rate in Canada is 15%. According to the uncovered interest rate parity, the Canadian dollar is expected to depreciate against the American dollar by approximately 5%. Put another way, to convince an investor to invest in Canada when its currency depreciates, the Canadian dollar interest rate would have to be about 5% higher than the American dollar interest rate.
Related Links:
Learn the basics of forward exchange rates and hedging strategies to understand interest rate parity. Using Interest Rate Parity To Trade Forex
Get a deeper understanding of the importance of interest rates and what makes them change. Forces Behind Interest Rates
Moving from equities to currencies requires you to adjust how you interpret quotes, margin, spreads and rollovers. A Primer On The Forex Market
Before entering this market, you should define what you need from your broker and from your strategy. Getting Started In Forex
Copyright ©2010, Investopedia.com - Owned and Operated by Investopedia US, A Division of ValueClick, Inc. All rights reserved.
