Interest rate parity

Interest rate parity implies that the interest rate will be the same in two different countries, adjusted for expected exchange rate change and the difference in risk.

In a country where the exchange rate is expected to weaken and where the risk of investing are higher, the interest rate will be higher than in the other country. Interest rate parity implies that the interest rate always is the same in two countries with floating exchange rates. The only difference in the interest rate will be matched by a risk premium. Using the theory of interest rate parity, one can see the expected exchange rate change between two countries if one knows the risk premium.

Example: interest rate Sweden = interest rate USA + expected exchange rate change + risk premium