Interest Rate Parity (IRP)

Forex & Currencies

Updated Apr 2026 • Has calculator

The no-arbitrage forward exchange rate implied by the interest rate differential between two countries.

What is Interest Rate Parity?

Covered interest rate parity (IRP) states that the forward exchange rate between two currencies must equal the spot rate multiplied by the ratio of their interest rates. If it did not, traders could lock in a risk-free profit by borrowing in the low-rate currency, converting at spot, investing at the high rate, and selling forward — a covered interest arbitrage. IRP is one of the most robust relationships in international finance because currency forwards are directly priced from it. Deviations from IRP signal either market stress (counterparty risk, capital controls) or trading costs.

Formula

F = S × (1 + r_d) ÷ (1 + r_f)

Worked Example

1-year forward, Q1 2024

Step 1 Spot USD/EUR: 1.0800 (1 EUR = $1.08 USD)

Step 2 US 1-year rate: 5.33% (Fed Funds)

Step 3 EUR 1-year rate: 3.50% (ECB deposit rate)

Step 4 F = 1.0800 × (1.0533 / 1.0350) = 1.0800 × 1.01769 = 1.0991

Step 5 → IRP implies a 1-year USD/EUR forward of ~1.0991; USD premium reflects higher US rates

Source: FRED — Federal Funds Rate & ECB Key Interest Rates (2024-03-31)

Calculate Interest Rate Parity

Spot Rate (domestic per foreign)

Current exchange rate: domestic currency per 1 unit of foreign currency

Domestic Interest Rate

1-year interest rate in the domestic (base) currency

Foreign Interest Rate

1-year interest rate in the foreign (quote) currency

Fair Forward Rate

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Not investment advice.

How to Interpret Interest Rate Parity

< 0

Invalid — spot rate must be positive

> 0

No-arbitrage forward rate. Compare to quoted forward to find deviation.

📚 Forex Basics — Complete the path

Sources