1. What is Interest Rate Parity?

Interest Rate Parity (IRP) is a fundamental concept in international finance that states that the difference in interest rates between two countries is equal to the differential between the forward exchange rate and the spot exchange rate.

2. How Does the Calculator Work?

The calculator uses the Interest Rate Parity formula:

Where:

• \( F \) — Forward exchange rate
• \( S \) — Spot exchange rate
• \( i_d \) — Domestic interest rate
• \( i_f \) — Foreign interest rate

Explanation: The formula shows the relationship between exchange rates and interest rates in different countries, ensuring no arbitrage opportunities exist.

3. Importance of Interest Rate Parity

Details: IRP is crucial for forex traders, multinational corporations, and investors to understand currency movements and hedge against exchange rate risk.

4. Using the Calculator

Tips: Enter the spot exchange rate, domestic interest rate, and foreign interest rate. All values must be positive numbers.

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between covered and uncovered IRP?
A: Covered IRP includes forward contracts to hedge risk, while uncovered IRP predicts future spot rates without hedging.

Q2: Does IRP always hold in real markets?
A: In practice, deviations can occur due to transaction costs, capital controls, or political risks, but arbitrage tends to restore parity.

Q3: How does inflation affect IRP?
A: Higher inflation typically leads to higher interest rates (Fisher effect) and currency depreciation, maintaining parity.

Q4: What time period should the interest rates cover?
A: The rates should match the forward contract period (e.g., use 1-year rates for 1-year forwards).

Q5: Can this be used for currency forecasting?
A: While useful, other factors like political stability and trade balances also affect exchange rates.