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Discuss the effect of Interest Rate Parity on USD and AUD exchange rates.

Discuss the effect of Interest Rate Parity on USD and AUD exchange rates.

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Expert Solution

Interest Rate Parity is a important factor in foreign exchange market which interconnecting between foreign exchange rate ,interest rates and spot exchange rate.Under this theory, returns should be the same from investing in different currencies,there is no importance in interest rates.IRP gives the understanding of the currency markets and it is useful to the Foreign exchange traders.IRP occurs only when the interest rate is same for  domestic and foreign assets. Proper understanding of IRP helps to find out the directions of currency rates.Through the application of IRP money will come to the market with higher interest rate.

The lower interest rate currency should trade at a forward premium with higher interest rate currency. For example the USD trade at forward premium against the AUD , otherwise AUD trades at a forward discount against USD. This the ultimate effect of IRP on USD and AUD.

jeff jeffy answered 1 year ago
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