Question

Question 6. In your own words, explain interest rate parity. Do we observe interest rate parity in the real-world data (e.g. between Canada and the United States)? Why or why not?

Answer 1

interest rate parity plays important role in today's international market. interest rate parity exists when the expected nominal rates are the same for both domestic and foreign assets.any difference is due to expected appreciation or depreciation in the foreign or domestic currencies.interest rate parity is that it doesn't matter whether a person invest money in their home country and their converts those earnings to another currency aur converts the money first and invest the money overseas.disparity theory states that relationship between the current exchange rate among two currencies and the forward rate is determined by the difference in the risk free rate offered for investors holding this currencies.

We observe interest rate parity in real world also suppose domestic interest rate is 7% and foreign interest rate is 3% this means that the market expects the foreign currency to appreciate by 4% or conversely investors expect the domestic currency to depreciate by 4%. in this condition it doesn't matter if an investor invest in a time for rent deposit and then convert the foreign currency to his domestic currency, or invest in a timed domestic deposit and then convert the domestic currency to the foreign currency.

suppose Canadian citizen get lower interest rate in USA then obviously they invest their currency in US to get more profit instead of investing in Canada.