Interest rate parity theory
In this lesson, you'll learn how interest rate parity theory predicts future exchange rates based on differences in interest rates between countries.
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In this lesson
- 0:00 Interest rate parity theory explained
- 1:02 Worked example: calculating forward rates
- 2:32 Interest rate parity formula breakdown
- 3:11 Exam question: six month forward rate
About this lesson
This concept is essential for FM and AFM papers, where you'll need to calculate forward exchange rates and understand why currency values shift when investment returns differ. The video walks you through the core principle: investors chase higher returns, which changes demand for currencies and therefore exchange rates. You'll see a worked example showing how to apply the interest rate parity formula, including the crucial detail of adjusting interest rates to match your time period (for example, converting annual rates to six-month rates). By the end, you'll be confident calculating forward rates in exam questions and understanding the economic logic behind the numbers.
Duration: 5m
Transcript
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