Aug 22

Interest rate parity (IRP) as cost of carry – 9 min screencast

by David Harper, CFA, FRM, CIPM

FRM |

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This is a screencast review of a problem recently posted to the forum: given two interest rates (domestic and foreign), what is the forward currency exchange rate? As Hull shows, this is really a cost of carry problem where the foreign rate replaces the dividend/convenience yield. Because fractions are tricky with exchange rate, I like to solve this way.

  • Pick one country as home country (it doesn’t matter which); e.g., England is home in this example
  • Scenario #1 is to invest at home
  • Scenario #2 is to “take a round trip” by investing abroad. No-arbitrage says I should be indifferent to the choice : the expect return should be the same in both cases.

Screencast:

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