Uncovered Interest Rate Parity (UIP)

Uncovered Interest Rate Parity (UIP)

Uncovered Interest Rate theory says that the expected appreciation (or depreciation) of a particular currency is nullified by lower (or higher) interest.
In the given example of covered interest rate, the other method that Yahoo Inc. can implement is to invest the money in dollars and change it for Euro at the time of payment after one month.
This method is known as uncovered, as the risk of exchange rate fluctuation is imminent in such transactions.

Covered Interest Rate and Uncovered Interest Rate

Contemporary empirical analysts confirm that the uncovered interest rate parity theory is not prevalent. However, the violations are not as huge as previously contemplated. The violations are in the currency domain rather than being time horizon dependent.
In contrast, the covered interest rate parity is an accepted theory in recent times amongst the OECD economies, mainly for short-term investments. The apparent deviations incurred in such models are actually credited to the transaction costs.


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