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Covered interest parity

Updated: Aug 20, 2021

A relationship between interest rates and exchange rates derived from the absence of an arbitrage opportunity.

Covered interest parity

Both these investments are risk-free (apart from inflation risk) since all values are known at the time of investment. They must therefore have the same return if there is no arbitrage.

The same argument can be repeated for investments of different lenghts thus linking the term structure of interest rates to forward exhange rates.

Reference: Oxford Press Dictonary of Economics, 5th edt.

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