Uncovered Interest Rate Parity - UIP
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Definition of 'Uncovered Interest Rate Parity - UIP'
A parity condition stating that the difference in interest rates between two countries is equal to the expected change in exchange rates between the countries’ currencies. If this parity does not exist, there is an opportunity to make a profit.
"i1" represents the interest rate of country 1
"i2" represents the interest rate of country 2
"E(e)" represents the expected rate of change in the exchange rate
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Investopedia explains 'Uncovered Interest Rate Parity - UIP'
For example, assume that the interest rate in America is 10% and the interest rate in Canada is 15%. According to the uncovered interest rate parity, the Canadian dollar is expected to depreciate against the American dollar by approximately 5%. Put another way, to convince an investor to invest in Canada when its currency depreciates, the Canadian dollar interest rate would have to be about 5% higher than the American dollar interest rate.
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