Covered Interest Rate Parity

AAA

DEFINITION of 'Covered Interest Rate Parity'

This term refers to a condition where the relationship between interest rates and the spot and forward currency values of two countries are in equilibrium. As a result, there are no interest rate arbitrage opportunities between those two currencies.

INVESTOPEDIA EXPLAINS 'Covered Interest Rate Parity'

As an example, assume Country X's currency is trading at par with Country Z's currency, but the interest rate in Country X is 6% and the interest rate in country Z is 3%. All other things being equal, it would make good sense to borrow in the currency of Z, convert it in the spot market to currency X and invest the proceeds in Country X. However, in order to repay the loan in currency Z, one must enter into a forward contract to exchange the currency back from X to Z. Covered interest rate parity exists when the forward rate of converting X to Z eradicates all the profit from the transaction.

RELATED TERMS
  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Currency Forward

    A binding contract in the foreign exchange market that locks ...
  3. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
  4. Interest Rate Parity

    A theory in which the interest rate differential between two ...
  5. Uncovered Interest Rate Parity ...

    A parity condition stating that the difference in interest rates ...
  6. Forex Spot Rate

    The current exchange rate at which a currency pair can be bought ...
Related Articles
  1. Options & Futures

    Using Interest Rate Parity To Trade Forex

    Learn the basics of forward exchange rates and hedging strategies to understand interest rate parity.
  2. Options & Futures

    Combining Forex Spot And Futures Transactions

    The spot, futures and option currency markets can be traded together for maximum downside protection and profit.
  3. Forex Education

    Why Interest Rates Matter For Forex Traders

    Central banks' rate changes are one of the biggest influences on the forex market.
  4. Forex Education

    8 Basic Forex Market Concepts

    We go over some of the things you need to understand before you can trade currencies.
  5. Forex Education

    Currency Carry Trades 101

    This strategy can provide returns even if the currency pair doesn't move a cent.
  6. Bonds & Fixed Income

    6 Factors That Influence Exchange Rates

    Find out how a currency's relative value reflects a country's economic health and impacts your investment returns.
  7. Forex Education

    Using Currency Correlations To Your Advantage

    Knowing the relationships between pairs can help control risk exposure and maximize profits.
  8. Forex

    How do companies benefit from interest rate and currency swaps?

    An interest rate swap involves the exchange of cash flows between two parties based on interest payments for a particular principal amount. However, in an interest rate swap, the principal amount ...
  9. Active Trading

    An Introduction To Depreciation

    Companies make choices and assumptions in calculating depreciation, and you need to know how these affect the bottom line.
  10.  investors are faced with a nearly overwhelming selection of potential investments. The first step is to look closer at the major financial markets.
    Investing Basics

    A Fresh Look At The Financial Markets

    Different markets provide unique opportunities and risks for investors. Find out more here.

You May Also Like

Hot Definitions
  1. Multinational Corporation - MNC

    A corporation that has its facilities and other assets in at least one country other than its home country. Such companies ...
  2. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  3. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  4. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  5. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
  6. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
Trading Center