Uncovered interest parity
The theory that the expected change in an exchange rate offsets the interest rate differential, so unhedged foreign deposits earn the same expected return. It often fails in the short run, which the carry trade exploits.
Where you will meet it
Uncovered interest parity appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Explain the international parity conditions, namely interest rate parity in its covered and uncovered forms, the international Fisher effect, purchasing power parity and forward rate parity
“Uncovered interest parity says the expected spot change equals the interest differential, so the high-yield currency should weaken by that amount.”
- Explain how yield curve positions are taken across more than one currency
“Carry trades that borrow in low-rate currencies and invest unhedged in high-rate ones are a bet that uncovered interest parity fails.”
- Set out the main approaches used to forecast currency movements
“Uncovered interest parity implies higher-yield currencies should depreciate, yet carry trades often profit for long periods before sharp reversals.”
- Contrast active currency approaches that rely on fundamentals-based valuation, technical analysis, carry trades or trading volatility
“The carry trade borrows low-yield currencies and invests in high-yield ones, profiting because uncovered interest parity fails in the short run; gains are steady but negatively skewed, with sharp losses when risk appetite collapses.”
See also
Practise it
Practise uncovered interest parity until it is automatic: questions that explain every wrong option.
Take the free diagnostic →