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Explanation and proof of the interest parity condition.

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Everyone pays a tax of 10 percent on interest and capital gains. Does this tax alter the analysis of the interest parity condition?

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Solution Summary

This solution is comprised of a simple explanation of how the payment of tax alters the interest parity condition.

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Before I answer this question, I'll discuss some of the fundamentals of interest parity (just in case you need a refresher).

The interest parity condition states that in an open economy, an interest rate above the world parity should lead speculators to expect a currency depreciation, not appreciation.

Covered interest parity is a condition that relates interest differentials to the forward premium or discount.

It begins with the interest parity condition:

(1+R) = ...

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