What this calculator does
Covered interest rate parity says the forward exchange rate is not a forecast. It is whatever rate makes borrowing in one currency, converting and investing in the other exactly as profitable as simply investing at home.
The gap between the two interest rates is what sets it. With a 3 per cent rate advantage over 180 days, a spot rate of 1.10 implies a forward rate of 1.116, and the currency paying more interest trades at a forward discount that exactly cancels the advantage.
The formula
The spot rate is multiplied by one plus the price currency rate for the period, divided by one plus the base currency rate for the same period. Rates are prorated over the actual days to settlement.
| Term | Meaning |
|---|---|
| Forward points | The difference between the forward and spot rates, quoted separately in the market. |
| Covered parity | The no-arbitrage relationship enforced by the ability to hedge with a forward contract. |
| Forward premium | When the forward rate exceeds spot, which happens when the price currency pays more interest. |
The inputs explained
| Field | What to enter |
|---|---|
| Spot exchange rate | The current spot exchange rate. |
| Price currency interest rate (annual, %) (%) | The annual interest rate on the price currency, the one being quoted. |
| Base currency interest rate (annual, %) (%) | The annual interest rate on the base currency. |
| Days until settlement | Days until the forward contract settles. |
When to use it
Pricing a forward contract
The fair forward rate follows from the two interest rates, not from any view on the currency.
Checking for arbitrage
A quoted forward materially away from parity implies a riskless trade, which rarely survives long.
Understanding the carry trade
Parity says the interest advantage should be cancelled by the forward rate, which is why carry trades rely on it not holding.
Worked examples
Every figure in the tables below is produced by this page’s own calculator at build time, so the numbers and the tool always agree. Select any row to load that scenario.
How do the forward points grow with time?
The same interest gap over three settlement horizons.
| Days to settlement | Forward rate | Forward points |
|---|---|---|
| 90 days | 1.108 | +0.0082 |
| 180 days | 1.116 | +0.0163 |
| 360 days | 1.132 | +0.0324 |
Questions
Is the forward rate a prediction?
No. It is an arbitrage relationship determined entirely by the two interest rates. Using it as a forecast is the single most common misunderstanding about currency forwards.
Why does the higher-yielding currency trade at a discount?
Because otherwise there would be free money. If you could earn 3 per cent more and lock in today's exchange rate, everyone would do it. The forward rate moves until that advantage is exactly cancelled.
Does covered parity always hold?
Very nearly, in normal conditions, since violations are directly arbitrageable. It broke down noticeably during the 2008 financial crisis and has shown persistent small deviations since, attributed to bank balance sheet costs.
What is uncovered parity?
The related claim that the expected future spot rate equals the forward rate. Unlike covered parity it is not enforced by arbitrage, and empirically it holds poorly, which is what makes carry trades profitable on average.
For the same carry logic applied to futures, see the futures fair value calculator. For rates implied between maturities, see the implied forward rate calculator.