💱 Interest Rate Parity Calculator
Calculate forward rates using Interest Rate Parity
How to Use This Calculator
Choose Calculation Type
Select whether you want to calculate the forward exchange rate or spot exchange rate.
Enter Interest Rates
Input the domestic interest rate and foreign interest rate (annual rates in percentage).
Enter Exchange Rate
If calculating forward rate, enter the spot rate. If calculating spot rate, enter the forward rate.
Review Results
See the calculated forward or spot rate, and premium/discount information.
Formula
(1 + rd) / (1 + rf) = F / S
Forward Rate: F = S × (1 + rd) / (1 + rf)
Spot Rate: S = F × (1 + rf) / (1 + rd)
Where: rd = Domestic rate, rf = Foreign rate, F = Forward rate, S = Spot rate
Example 1: Calculate Forward Rate
Domestic Rate: 3.0%, Foreign Rate: 2.0%
Spot Rate: 1.1000
Forward Rate = 1.1000 × (1.03 / 1.02) = 1.1000 × 1.0098 = 1.1108
The currency with higher interest rate trades at forward premium
About Interest Rate Parity Calculator
The Interest Rate Parity Calculator calculates forward exchange rates using Interest Rate Parity (IRP) theory, which states that the difference between forward and spot exchange rates should equal the interest rate differential between two countries. IRP ensures that returns are equalized across currencies, preventing arbitrage opportunities.
Interest Rate Parity is a fundamental concept in international finance that links interest rates and exchange rates. When interest rates differ between countries, exchange rates adjust to equalize returns. The currency with the higher interest rate trades at a forward premium, while the currency with the lower interest rate trades at a forward discount.
This calculator is essential for forex traders, international businesses, investors, and anyone studying international finance. It helps understand forward pricing, evaluate currency strategies, assess arbitrage opportunities, and understand the relationship between interest rates and exchange rates.
When to Use This Calculator
- Forex Trading: Calculate forward rates for currency trading
- Currency Hedging: Determine forward rates for hedging currency exposure
- Investment Analysis: Evaluate currency investment opportunities
- Academic Study: Learn about Interest Rate Parity and exchange rates
- Arbitrage Analysis: Assess arbitrage opportunities in currency markets
- International Business: Understand forward pricing for international transactions
Why Use Our Calculator?
- ✅ Accurate Calculations: Uses Interest Rate Parity formula
- ✅ Versatile: Can calculate forward or spot rates
- ✅ Educational: Helps understand IRP concepts
- ✅ Easy to Use: Simple interface for quick calculations
- ✅ Free Tool: No registration or fees required
- ✅ Comprehensive: Shows premium/discount information
Understanding Interest Rate Parity
Interest Rate Parity states that the forward premium or discount should equal the interest rate differential between two countries. If domestic interest rates are higher than foreign rates, the domestic currency trades at a forward premium. This compensates for the interest rate difference, ensuring that returns are equalized across currencies and preventing arbitrage.
IRP ensures that investors cannot earn risk-free profits by borrowing in one currency and investing in another. If IRP didn't hold, arbitrageurs would exploit the difference, causing exchange rates to adjust until IRP is restored. In practice, IRP generally holds due to arbitrage activities.
Real-World Applications
Currency Hedging: Companies use IRP to understand forward pricing when hedging currency exposure. If USD interest rates are 3% and EUR rates are 1%, the USD/EUR forward rate will be higher than the spot rate, reflecting the 2% interest rate differential.
Forex Trading: Traders use IRP to evaluate forward contracts and assess whether forward rates are consistent with interest rate differentials. Deviations from IRP may indicate trading opportunities or market inefficiencies.
Investment Strategy: Investors use IRP to understand the relationship between interest rates and exchange rates when making international investments, helping them assess currency risk and returns.
Important Considerations
- IRP assumes no transaction costs, which may not hold in practice
- IRP may not hold perfectly due to risk premiums, capital controls, or market frictions
- Covered IRP (with forward contracts) typically holds better than uncovered IRP
- Interest rates should match the forward contract period
- IRP is a theoretical relationship; actual rates may deviate due to various factors
- Currency with higher interest rate typically trades at forward premium
Frequently Asked Questions
What is Interest Rate Parity?
Interest Rate Parity (IRP) is a theory stating that the difference between forward and spot exchange rates should equal the interest rate differential between two countries. It ensures that returns are equalized across currencies, preventing arbitrage opportunities.
How does Interest Rate Parity work?
IRP states that (1 + r_d) / (1 + r_f) = F / S, where r_d is domestic interest rate, r_f is foreign interest rate, F is forward rate, and S is spot rate. The currency with higher interest rates trades at a forward premium to compensate for the interest rate difference.
Why does the higher interest rate currency trade at premium?
The currency with higher interest rates trades at a forward premium to compensate investors for the interest rate difference. This ensures that returns are equalized across currencies, preventing risk-free arbitrage profits from borrowing in low-interest currencies and investing in high-interest currencies.
Does Interest Rate Parity always hold?
IRP generally holds in efficient markets due to arbitrage activities, but it may not hold perfectly due to transaction costs, risk premiums, capital controls, or market frictions. Covered IRP (with forward contracts) typically holds better than uncovered IRP (without forward contracts).
What is the difference between covered and uncovered IRP?
Covered IRP uses forward contracts to hedge exchange rate risk, ensuring equalized returns with certainty. Uncovered IRP doesn't use forward contracts and relies on expected future spot rates, which introduces uncertainty. Covered IRP typically holds better in practice.
How is IRP used in currency trading?
Traders use IRP to evaluate forward contracts, assess whether forward rates are consistent with interest rate differentials, and identify potential arbitrage opportunities. Deviations from IRP may indicate trading opportunities or market inefficiencies that can be exploited.