Covered vs Uncovered Interest Rate Parity

CFA Level II
#1

Could somebody conceptually explain the difference between covered and uncovered interest rate parity?

#2

covered interest rate parity connects price of spot, forward and interest rates: F = S*(1+Rdc)/(1+Rfc) and stands by arbitrage (has to be true at all times - otherwise there is an arbitrage opportunity). uncovered interest rate parity connects price of spot, expected spot price and inflation rates: E(S) = S*(1+Idc)/(1+Ifc) and doesn’t stand by arbitrage.

#3

Thanks Maratikus

#4

maratikus Wrote: ------------------------------------------------------- > covered interest rate parity connects price of > spot, forward and interest rates: > > F = S*(1+Rdc)/(1+Rfc) and stands by arbitrage (has > to be true at all times - otherwise there is an > arbitrage opportunity). > > uncovered interest rate parity connects price of > spot, expected spot price and inflation rates: > > E(S) = S*(1+Idc)/(1+Ifc) and doesn’t stand by > arbitrage. Maratikus… the second one is Purchasing Power Parity (expected spot price and inflation rates) Uncovered IRP: Countries with high nominal IR should see there currency depreciate E(S1)/S0 = [(1 + Rfc) / ( 1 + Rdc )] Spot in FC/DC

#5

you are correct, chadtap. I messed up in my post.