FX Question

Could someone reiterate to me again what the effects of the interest rate are considering IRP? Does it mean that DC is cheaper / will appreciate if 1+rd is lower than 1+rf? I know how to make use of the IRP on the whole, but want to be prepared for “depreciating/appreciating” type questions too and wasn’t too sure about that aspect.

If Rd

coolio, thank you

^ Except that has nothing to do with IRP or the question nor is it even true. That answer has something to do with changing interest rates, not their absolute levels. If Rd < Rf, then the domestic currency is expected to appreciate relative to the foreign currency. The easy way to see this is that you have two choices for holding cash in this situation: a) Invest at Rd while buying foreign currency forward b) Convert at spot and invest at Rf. Since both of these must give you the same return, the domestic currency must be expected to appreciate in the forward market. If not, covered interest arb gives you a guaranteed profit.

aha, i understand better now.