Schweser’s book 3 page 95: Professor’s Note: If the nominal domestic interest rate is low relative to the nominal foreign interest rate, the foreign currency must trade at a forward discount (this relationship is forced by arbitrage). Alternatively, if the nominal home interest rate is high relative to the nominal foreign interest rate, the foreign currency must trade at a forward premium. I’m at a loss to understand this controversial concept. Can anybody clarify?
Always remember real interest rates are equal across the countries (fisher rule) , so that means whatever is the nominal interest rate difference will be equal to inflation difference in the countries. Country with high nominal interest rate will have high inflation hence it will trade at discount in future since high inflation will eat away the currency. Country with low nominal interest rate will have low inflation so it will trade at premium , since in low inflation environment currency will appreciate.