Covered Interest Rate Parity

Covered Interest Rate Parity

The principle that the yields from interest-bearing foreign and domestic investments should be equal when the currency market is used to predetermine the domestic currency payoff from a foreign investment. For example, suppose interest on 90 U.K. Treasury bills is 4% but only 1% in U.S. When the U.S. investor tries to take advantage of the higher yield, they translate U.S. dollars to Sterling to buy the Treasury bill and then sell 90-days forward Sterling (so they can translate the principal and interest back to U.S. dollars). Covered Interest Parity ensures that the return to this transaction is 1%. If it was different, there would be arbritrage.

Covered Interest Rate Parity

The principle stating that yields from two equivalent investments in the domestic market and the foreign market, respectively, are equal after accounting for fluctuations in the exchange rate. See also: Purchasing power parity, Covered interest rate arbitrage.
References in periodicals archive ?
In these markets, the law of one price implies the covered interest rate parity (CIP) condition.
Verdelhan, "Deviations from Covered Interest Rate Parity," NBER Working Paper No.
Using weekly information on short-term interest rates and spot and forward exchange rates for a set of 20 European economies during 2005-2017, we show that in most cases these bases are non-stationary, implying the failure of the Covered Interest Rate Parity condition.
Under the covered interest rate parity (CIRP), the relationship between interest rates and the spot and forward currency values of two countries are in equilibrium, with virtually no pure arbitrage opportunities (Madura, 2007).
(1992), "Non-Reversed Investment and Borrowing, Transactions Costs and Covered Interest Rate Parity," International Review of Economics and Finance 1(2): 107-119.
* the covered interest rate parity for the case in which a futures contract is entered into;
Although both domestic and international interest rates fell (SBI and JIBOR respectively fell from 9.53% to 8.66% and from 9.95% to 8.85%, while SIBOR dropped from 1.135% to 1.118%), but the decline in the swap premium rate significantly improved covered interest rate parity (CIP) from -0.76% to 0.02%.
Table 1 presents five measures used in the literature to quantify the degree of capital mobility - (i) covered interest rate parity (CIP), (ii) uncovered interest parity (UIP), (iii) real interest rate parity (RIP), (iv) saving-retention coefficient (Feldstein and Horioka 1980), and (v) the offset coefficient (Argy and Kouri 1974 and Kouri and Porter 1974).
Adrien Verdelhan and coauthors Wenxin Du, and Alexander Tepper received the AQR Insight Award for their paper on "The Deviations from Covered Interest Rate Parity."
Amid the declining trend in general with slight increase in Singapore inter bank offered rate (SIBOR), the decline in swap premium caused covered interest rate parity to improve to -0.02% in April from -20% in Mach.