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Currency risk management

Interest rate parity theory (IRPT)

3.1 Interest rate parity

 Difference between spot and forward rates is equal to the differential between
interest rates available in the two currencies.

 Equivalently, both countries have the same real interest rate (Fisher Effect).

 Country with higher interest rates will suffer a fall in the value of their currency.

1+ i
 Forward rate = Current spot rate × f , where i = money interest rates.
1+ i
h

 Assumes rates are quoted as indirect quotes.

3.2 Limitations

 Controls on capital markets.

 Controls on currency trading.

 Government intervention.

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