Covered and Uncovered Interest Rates

What is the difference in computing the covered and uncovered interest rates? The workings appear similiar.

In covered interest rate parity, the investor locks in a forward exchange rate, and the investment is hedged against currency risks. This parity creates a no-arbitrage condition.

In uncovered interest rate parity, the investor is counting on an expected future spot rate and hasn’t locked in a forward exchange rate, and the investment is unhedged against currency risks. This parity is said to work mostly in theory because it’s hard to accurately predict future spot rates.

I think in the test, the data provided in the item sets would hint at which concept to apply in your calculations. The biggest hint is that if a forward rate is implemented in an investment, it would likely ask for the covered parity. If a forward rate is not mentioned, it would likely ask for the uncovered parity.

Interest rate parity is interest rate parity: the formula is the same whether it’s covered or uncovered.

The only difference is that in covered IRP you have a forward (or futures) contract that ensures the future exchange rate, while in uncovered IRP you have crossed fingers.