The interest rate parity theory relates forward or future spot exchange rates to differences in interest rates between two countries adjusted by the spot rate.

Question

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The interest rate parity theory is based on the idea that the expected return on a foreign currency investment should be equal to the return on a domestic currency investment, when adjusted for the exchange rate. This is expressed in the equation: (1+Rfc)/(1+Rdc) = (1+f)/(1+s), where R is the interest rate, f is the forward rate, and s is the spot rate. The theory is used to explain and predict exchange rate movements.

The Interest Rate Parity Theory Relates Forward or Future Spot