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Interest rate parity theorem

• Interest rates in different countries are generally different because of the differences in inflation rates. Interest rate parity holds if the differences in interest rates are exactly offset by differences in inflation rates and the resulting currency depreciation. Assume that the risk-free interest rate in the US is 5% and in Mexico 15%. Assume that it takes 10 pesos to USD now and one-year forward price is 10.952381 MP/USD. If you invest $1000 now, next year, you end up with $1050 USD. If you convert $1000 into pesos now, you end up with 10,000 MP, lend them at 15%, and end up with 11,500 MP, convert them back into USD at the forward price of 10.95, you end up with exactly $1050 USD next year, which is exactly the same as if you lent in the US. This is an example of interest rate parity.

• Interest rate differential between two countries is equal to the difference between the forward foreign exchange rate and the spot rate.

 
 

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 Embedded terms in definition
 Currency
Depreciation
Exchange rate
Exchange
Foreign exchange rate
Foreign exchange
Foreign
Forward
Inflation
Interest rate
Interest
Lend
Offset
Parity
Spot rate
 
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Accrued interest
Add on rate
Adjustable rate mortgage
Adjustable rate or floating rate preferred share arps
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After tax real rate of return
All current rate method
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Amortizing interest rate swap
Annual percentage rate
Annuity rate
Arithmetic average mean rate of return
Auction rate preferred stock
Average rate of return
Average tax rate
Back discount rate
Bank rate
Base interest rate
Base rate
Benchmark interest rate
Break even payment rate
Break even tax rate
Broker loan rate
Call money rate
Capitalization rate
Capitalized interest
Cash flow after interest and taxes
Ccpc rate reduction
Compound annual growth rate
Compound interest
Compounded interest
Conversion parity price
Coupon rate
Covered interest arbitrage
Crediting rate
Cross over rate
Crossover rate
Current rate method
Debt service parity approach
Discount rate
Dividend rate
Dollar weighted rate of return
Earnings before interest and taxes
Effective annual interest rate
Effective interest rate international context
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Effective true annual rate
Equilibrium rate of interest
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Exchange rate mechanism
Exchange rate risk
Exchange rate risk capital budgeting
Federal funds rate
Fisher's separation theorem
Fixed exchange rate
Fixed rate loan
Fixed rate payer
Floating exchange rate
Floating rate
Floating rate bonds
Floating rate contract
Floating rate loan
Floating rate note
Floating rate payer
Floating rate preferred
Floating rate preferreds
Floor rate
Foreign exchange rate
Forward exchange rate
Forward interest rate
Forward rate
Forward rate agreement
Future value interest factor
Future value interest factor for an annuity
Gross interest
Growth rate
Guaranteed investment interest contract
Historical exchange rate
Hurdle rate
Implied repo rate
Incremental internal rate of return
Indication of interest
Interest
Interest calculations and related formulas
Interest compounded annually
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Interest coverage
Interest coverage ratio
Interest coverage test
Interest discounted annually present value of reversion
Interest discounted continuously
Interest equalization tax
Interest equivalent factor
Interest impact on accumulation of 1 per period
Interest impact on instalment to amortize or amortization
Interest impact on present value of ordinary annuity of 1 per period
Interest impact on sinking fund factor
Interest on interest
Interest only
Interest only strip
Interest payments
Interest rate
Interest rate agreement
Interest rate buydowns
Interest rate cap
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Interest rate exposure
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Interest rate on debt
Interest rate risk
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Interest tax shield
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Internal rate of return irr
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Lease rate
London interbank offered rate libor
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Parity
Parity value
Pass through coupon rate
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Pibor paris interbank offer rate
Plowback rate
Portfolio internal rate of return
Portfolio separation theorem
Portfolio turnover rate
Present value interest factor
Present value interest factor for an annuity
Prime rate
Purchasing power parity
Put call parity relationship
Rate anticipation swaps
Rate lock
Rate of interest
Rate of return
Rate of return ratios
Rate risk
Rate sensitive assets
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Real interest rate
Real rate of interest
Real rate of return
Reference rate
Reinvestment rate
Relative purchasing power parity
Retention rate
Risk adjusted discount rate
Risk free rate
Riskless rate
Separation theorem
Settlement rate
Short interest
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Split rate tax system
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Spot futures parity theorem
Spot interest rate
Spot rate
Spot rate curve
Stated annual interest rate
Stopping curve refunding rate
Sustainable growth rate
Swap interest rate
Swap rate
Term structure of interest rates
Term structure of interest rates and volatility
Theoretical spot rate curve
Time weighted rate of return
Times interest covered
Times interest earned ratio
Total rate of return
True interest cost
Two fund separation theorem
Unemployment rate
Unisex annuity rate
Variable rate cds
Variable rate loan

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