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FX/Interest Rate Parity Question
I am having trouble understanding the relationship between FX rates and interest rates. Under interest rate parity, the country with the lower interest rate experiences currency appreciation, so that the real returns between countries become equal. If real returns are not equal, covered interest arbitrage is possible. But, in contrast, one of the factors that can cause a country's currency to appreciate or depreciate is differences in interest rates, where low interest rates cause capital to be invested elsewhere leading to decreased demand for the currency, and depreciation. It seems that the two factors, interest rate parity and using interest rates as a measure of investment opportunities, and as a result capital flows don't jive? Am I missing something? |
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