Net Interest Rate Differential

DEFINITION of 'Net Interest Rate Differential'

In international markets, the difference in the interest rates of two distinct economic regions. If a trader is long the NZD/USD pair, he or she owns the New Zealand currency and borrows the US currency. These New Zealand dollars can be placed into a New Zealand bank while simultaneously taking out a loan for the same amount from the U.S. bank. The net interest rate differential is the difference in any interest earned and any interest paid while holding the currency pair position.

BREAKING DOWN 'Net Interest Rate Differential'

The net interest rate differential reveals the difference in interest rates offered between two countries. This differential is typically used to price currency forward contracts through the interest rate parity equation. A discrepancy between fundamental parity conditions and actual interest rates offered presents a currency arbitrage opportunity.