Covered Interest Rate Parity
The principle that the yields from interest-bearing foreign and domestic investments should be equal when the currency market is used to predetermine the domestic currency payoff from a foreign investment. For example, suppose interest on 90 U.K. Treasury bills is 4% but only 1% in U.S. When the U.S. investor tries to take advantage of the higher yield, they translate U.S. dollars to Sterling to buy the Treasury bill and then sell 90-days forward Sterling (so they can translate the principal and interest back to U.S. dollars). Covered Interest Parity ensures that the return to this transaction is 1%. If it was different, there would be arbritrage.
Nearby TermsCovered foreign currency loan Covered interest arbitrage Covered Interest Rate Parity Covered option Covered or hedge option strategies
Copyright © 2011 Campbell R. Harvey, Professor of Finance, Fuqua School of Business at Duke University