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Macroeconomics

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Uncovered Interest Rate Parity Calculation

MACRO-TYQNAC

The uncovered interest rate parity condition may hold in the short run if currency traders are free to pursue arbitrage profits, and the risk premium over the sure domestic rate of return compared to the risky foreign return (due to exchange rate risk) is negligible.

Suppose the spot price of British pounds is \$1.40 per pound. Further suppose that the interest rate on very safe bonds is 2% when denominated in U.S. dollars and 4% when denominated in British pounds.