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Interest rate parity between the USA and the United Kingdom

What is interest rate parity and does one exist between the United States and the United Kingdom?

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The relationship can be seen when you follow the two methods an investor may take to convert foreign currency into U.S. dollars. Option A would be to invest the foreign currency locally at the foreign risk-free rate for a specific time period. The investor would then simultaneously enter into a forward rate agreement to convert the proceeds from the investment into U.S. dollars, using a forward exchange rate, at the end of the investing period. Option B would be to convert the foreign currency to U.S. dollars at the spot exchange rate, then invest the dollars for the same amount of time as in option A, at the local (U.S.) risk-free rate. When no arbitrage opportunities exist, the cash flows from both options are equal.


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Solution Summary

The interest rate parity between the United States and the United Kingdom is examined. The expert analyzed covered interest rate parity.