Uncovered Interest Rate Parity
When the no-arbitrage condition is satisfied without the use of a forward contract to hedge against exposure to exchange rate risk, interest rate parity is said to be uncovered. Risk-neutral investors will be indifferent among the available interest rates in two countries because the exchange rate between those countries is expected to adjust such that the dollar return on dollar deposits is equal to the dollar return on foreign deposits, thereby eliminating the potential for uncovered interest arbitrage profits. Uncovered interest rate parity helps explain the determination of the spot exchange rate. The following equation represents uncovered interest rate parity.
where
- is the expected future spot exchange rate at time t + k
- k is the number of periods into the future from time t
- St is the current spot exchange rate at time t
- i$ is the interest rate in the US
- ic is the interest rate in a foreign country or currency area (for this example, following a US perspective, it is the interest rate available in the Eurozone)
The dollar return on dollar deposits, is shown to be equal to the dollar return on euro deposits, .
Read more about this topic: Interest Rate Parity
Famous quotes containing the words uncovered, interest, rate and/or parity:
“At last the gathered show lets down as white
As may be in dark woods, and with a song
It shall not make again all winter long
Of hissing on the yet uncovered ground,”
—Robert Frost (1874–1963)
“You do not mean by mystery what a Catholic does. You mean an interesting uncertainty: the uncertainty ceasing interest ceases also.... But a Catholic by mystery means an incomprehensible certainty: without certainty, without formulation there is no interest;... the clearer the formulation the greater the interest.”
—Gerard Manley Hopkins (1844–1889)
“At this very moment,... the most frightful horrors are taking place in every corner of the world. People are being crushed, slashed, disembowelled, mangled; their dead bodies rot and their eyes decay with the rest. Screams of pain and fear go pulsing through the air at the rate of eleven hundred feet per second. After travelling for three seconds they are perfectly inaudible. These are distressing facts; but do we enjoy life any the less because of them? Most certainly we do not.”
—Aldous Huxley (1894–1963)
“The U.S. is becoming an increasingly fatherless society. A generation ago, an American child could reasonably expect to grow up with his or her father. Today an American child can reasonably expect not to. Fatherlessness is now approaching a rough parity with fatherhood as a defining feature of American childhood.”
—David Blankenhorn (20th century)