Interest rate parity is an important concept. If the interest rate parity relationship does not hold true, then you could make a riskless profit. ... If the forward price you locked in was higher than the IRP equilibrium forward price, then you would have more than the amount you must pay back.

How to Calculate Covered Interest Rate Parity. Covered interest rate parity is calculated as: One plus the interest rate in the domestic currency should equal. The forward foreign exchange rate divided by the current spot foreign exchange rate.

2)A currency with lower interest rates will trade at a forward premium in relation to a currency with a higher interest rate. For example, the U.S. dollar typically trades at a forward premium against the Canadian dollar. Conversely, the Canadian dollar trades at a forward discount versus the U.S. dollar.

Covered interest rate parity is calculated as: One plus the interest rate in the domestic currency should equal. The forward foreign exchange rate divided by the current spot foreign exchange rate. Times one plus the interest rate in the foreign currency.

3)For example, if two goods differ in price (expressed in a common currency) in different countries because PPP does not hold, it won't be worth arbitraging and therefore correcting the price difference unless the anticipated profit exceeds the cost of shipping goods between the two locations.

The absolute PPP calculation is calculated by dividing the cost of a good in one currency, by the cost of a good in another currency (usually the US dollar).

4)If the Fisher hypothesis does hold, the real interest rate must be independent of changes in inflation and monetary shocks at any given time. In other words, evidence in support of the Fisher hypothesis indicates the neutrality of monetary policy, i.e. the ineffectiveness of monetary policies.

Calculating the Fisher effect is not difficult. The technical format of the formula is “Rnom = Rreal + E[I]” or nominal interest rate = real interest rate + expected rate of inflation. An easier way to calculate the formula and determine purchase power is to break the equation into two steps.

5)The International Fisher Effect (IFE) states that differences in nominal interest rates between countries can be used to predict changes in exchange rates

How to Calculate the Fisher Effect

E = [(i1-i2) / (1+ i2)] ? (i1-i2)

1.3 x (1.05/1.06) = 1.312.

(1 + Nominal Interest Rate) = (1+Real Interest Rate) (1+Inflation Rate)