Question from website topic test (Derivatives section, hence posting it under Derivatives category)
My confusion is when interest rates are high in currency A, currency will fall due to IRP convergence or will the currency rise as more capital will flow into currency A.
If the difference is about short term vs long term, what is the threshold to consider a time period as short term ?
The CFA curriculum states that covered IRP is not an appropriate predictor of spot rates in future. This means that the forward rate we obtain from CIRP does not indicate what the future spot rate will be and thus should not be given any weightage in this regard. In fact, the concept of carry trade in currencies is based on the fact that the forward rate from this IRP does not predict Spot rate in future. So, given that real interest rate of euro-based countries is higher, it does not imply that future spot rates will be lower. Instead, it implies that such countries would attract more investments thereby appreciating euro.
Thank You