Covered Interest rate parity stronger, interest, equation, canadian, understand

sabaruch

say the CAN$/US$ spot rate is 1.5
interest rate in Canada is 5%
interest rate in U.S. is 2%

what is the forward rate?

I understand the formula: So x (1+Rdc)^T/(1+Rfc)^T

however, if the canadian interest rate is higher (numerator in the equation) then wouldn't the Canadian dollar get weaker? In theory if rates are higher in Canada the Canadian dollar should get stronger.

what am I doing wrong?

MiniMe7

It can look odd, but the currency with the greater interest rate is the one set to decline. Think about it as an offset. For parity to hold what a currency offers in greater (less) interest must be balanced by a forward discount (premium).

It is true and confusing that greater real interest rates attract inflows from abroad, and create currency appreciation. But you have to assume that has already happened, and consider only the price relationships between two currencies today and in the future.

stalkey

Anyone else?

President1988

based on nominal interest rates which is the real rate and inflation combined. as real rates are assumed equal [IFR] (capital inflows will create equality), the only difference between two IR's is their respective inflation rates. Under PPP, the higher inflation will depreciate the currency.

luda002

answer is 1.54418. in other words, the USD has improved by 2.9%