1. What is Interest Rate Parity (Simple)?

The Interest Rate Parity (IRP) theory states that the forward exchange rate should compensate for the interest rate differential between two countries. The simple version assumes no arbitrage opportunities in perfect capital markets.

2. How Does the Calculator Work?

The calculator uses the IRP simple equation:

Where:

• \( Forward \) — Forward exchange rate
• \( Spot \) — Current spot exchange rate
• \( Domestic\ Rate \) — Domestic interest rate (%)
• \( Foreign\ Rate \) — Foreign interest rate (%)

Explanation: The equation shows that the currency with higher interest rate will trade at a forward discount, while the currency with lower interest rate will trade at a forward premium.

3. Importance of IRP Calculation

Details: IRP is fundamental in foreign exchange markets, helping investors and corporations hedge currency risk and understand expected exchange rate movements based on interest rate differentials.

4. Using the Calculator

Tips: Enter spot exchange rate, domestic interest rate (%), and foreign interest rate (%). All values must be valid (spot > 0, rates ≥ 0).

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between simple and covered IRP?
A: Simple IRP is a basic version, while covered IRP accounts for actual forward contracts and arbitrage opportunities.

Q2: Does IRP hold in real markets?
A: It generally holds for major currencies with open capital markets, but deviations can occur due to transaction costs or capital controls.

Q3: How does inflation affect IRP?
A: Inflation differentials are indirectly accounted for through nominal interest rates (Fisher effect).

Q4: What time period does this calculation assume?
A: The calculation assumes the interest rates are for the same time period as the forward contract (typically 1 year).

Q5: Can this be used for forecasting exchange rates?
A: It provides an equilibrium forward rate, but actual future spot rates may differ due to risk premiums and unexpected events.