Business, Legal & Accounting Glossary
An arbitrage condition that must hold between the spot interest rates of different currencies.
Interest rate parity is a relationship that must hold between the spot interest rates of two currencies if there are to be no arbitrage opportunities.
The relationship depends upon spot and forward exchange rates between the currencies.
In formula , the interest rates are assumed to be annually compounded commercial rates, such as Libor rates. If they are continuously compounded, formula  becomes:
where and are continuously compounded rates, and e is the natural log base (2.718281828…).
Interest rate parity plays a fundamental role in foreign exchange markets, enforcing an essential link between short-term interest rates, spot exchange rates, and forward exchange rates.
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This glossary post was last updated: 4th August, 2021 | 3 Views.