@Ju1882 4 August 2020 more from that month

Interest Rate parity theory - Foreign Exchange

****Interest Rate parity theory**** Interest Rate parity theory states that foreign exchange rate between currencies are directly dependent on their interest rate differential. As per this theory, in a free and efficient market, interest arbitrage is not possible. If interest rate of a currency is higher, the currency will be at discount in future, the gain of higher interest rate will be set-off by loss on account of discount in currency value and vice-versa. Let " X " and " Y " be two currency. According to Interest Rate parity theory, whether you invest in " X " and " Y " , on maturity your relative wealth will be same. According to Interest Rate parity theory, the rate of Discount/Premium of currency " X " (in comparison with currency " Y " = ( Ry - Rx ) / ( 1 + Rx ) Where, Rx and Ry is Real Rate of Interest of currency " X " and " Y " respectively. ****Real Rate of Interest (The Fisher Effect)**** According to Prof. Fisher, the expected inflation rate of a country has an important effect on money- interest rate ( also known as Nominal-Interest rate) in the country. Nominal-Interest rate is effected by Inflation rate. The Fisher principal of interest rate is - ( 1 + Real Interest rate ) X ( 1 + Inflation rate ) = ( 1 + Nominal-Interest rate ) ****Example**** If real rate of interest is 10%, inflation rate is 20% then, Nominal-Interest rate=(1 + 0.10) X ( 1+0.20) => Nominal-Interest rate = 1.32 => Nominal-Interest rate is 32%. Thank you for reading.