Interest rate parity (IRP)

What it means

The condition that the forward exchange rate differs from the spot rate by exactly the interest rate differential, so hedged returns are equal across currencies.

The exam angle

Covered parity is an arbitrage relationship and holds tightly. Uncovered parity is an expectation and does not — that gap is what the carry trade harvests.

Where it appears in the syllabus

• EconomicsCFA Level I · exam weight 6–9% · Market structures, business cycles, policy, trade and exchange rates.
• EconomicsCFA Level II · exam weight 5–10% · Two dense modules: currency equilibrium value and economic growth.
• Valuation & Risk ModelsFRM Part I · exam weight 30% · VaR and ES, option valuation, bond risk, stress testing, credit and op risk.

Related terms

• Purchasing power parityThe proposition that exchange rates adjust so that identical goods cost the same across countries.
• Yield curveThe relationship between yield and maturity for bonds of the same credit quality.
• Adverse selectionThe problem that arises when the party with better information self-selects into a transaction, leaving the…
• Business cycleThe recurring pattern of expansion, peak, contraction and trough in economic activity.
• Core inflationInflation excluding food and energy prices, which are volatile and often driven by supply rather than demand.
• Fiscal policyGovernment use of spending and taxation to influence aggregate demand.