Interest Rate Parity Calculator
Calculate forward exchange rates using the interest rate parity (IRP) theory. This fundamental principle in international finance explains the relationship between interest rates and exchange rates.
Current Exchange Rate
Interest Rates (%)
Time Period
Forward Exchange Rate
Forward Rate:
0.0000
Forward Premium/Discount:
Expected Spot Rate:
0.0000
Arbitrage Analysis
Arbitrage Opportunity:
None
Covered Interest Differential:
0.00%
Market Efficiency:
Efficient
Investment Returns
Domestic Return:
0.00%
Foreign Return:
0.00%
Covered Return Differential:
0.00%
Understanding Interest Rate Parity
Interest rate parity (IRP) is a fundamental concept in international finance that explains the relationship between interest rates and exchange rates. It states that the difference in interest rates between two countries should be equal to the difference between the forward exchange rate and the spot exchange rate.
Interest Rate Parity Formula
Covered Interest Rate Parity
- F0 = S0 × (1 + i_d) / (1 + i_f)
- F0 = Forward exchange rate
- S0 = Spot exchange rate
- i_d = Domestic interest rate
- i_f = Foreign interest rate
Uncovered Interest Rate Parity
- E[S1] = S0 × (1 + i_d) / (1 + i_f)
- E[S1] = Expected future spot rate
- No forward contract
- Based on expectations
Covered Interest Arbitrage
Arbitrage Strategy
When Domestic Rate > Foreign Rate
- Borrow in foreign currency
- Convert to domestic currency
- Invest domestically
- Sell forward contract
- Lock in risk-free profit
When Foreign Rate > Domestic Rate
- Borrow in domestic currency
- Convert to foreign currency
- Invest in foreign market
- Buy forward contract
- Guaranteed higher return
Applications in Finance
| Application | How IRP Helps | Key Insight |
|---|---|---|
| Currency Hedging | Determine fair forward rates | Eliminate currency risk |
| Investment Strategy | Compare international returns | Risk-adjusted performance |
| Central Banking | Monetary policy coordination | Exchange rate stability |
| Risk Management | Forward rate forecasting | Expected exchange rates |
IRP and Market Efficiency
Efficient Markets
- No arbitrage opportunities
- Forward rates reflect fair value
- Interest differentials explain premiums
- Capital flows freely
Market Inefficiencies
- Transaction costs
- Capital controls
- Political risk
- Market segmentation
IRP Assumptions
Key Assumptions
- Perfect capital mobility
- No transaction costs
- Risk-neutral investors
- Same investment horizon
Real World Deviations
- Currency controls
- Different tax treatments
- Credit risk differences
- Market imperfections
Key Takeaways for Interest Rate Parity Calculator
- Interest rate parity explains the relationship between interest rates and exchange rates
- The covered version eliminates exchange rate risk through forward contracts
- The calculator determines the fair forward exchange rate based on interest rate differentials
- When IRP holds, there are no arbitrage opportunities in covered interest arbitrage
- Deviations from IRP indicate market inefficiencies or barriers to capital flows
- IRP is fundamental to international finance and currency trading strategies
- The calculator helps identify whether currencies are at fair value
- Use the calculator to understand currency hedging and international investment strategies