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In this approach to interest rate parity, the return on domestic deposits must equal the return on foreign deposits measured in dollars. By using the formula (1+Rt) = Ee x {(1+R€) / Et}, or rearranging to find Et, the spot exchange rate ($/€) can be determined for given values of R€ and Ee. The equation involves the gross return on foreign deposits (1 + R€), the gross return on domestic deposits right now (1 + Rt), and the expected future exchange rate. There is an inverse relationship between Et and Rt that plays a crucial role in this concept.
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Interest Rate Parity ReduxA (slightly) different approach • Return on domestic deposits (R) must equal return on foreign deposits measured in $ (1+Rt) = Ee x {(1+R€) / Et } or Et = {(1+R€) / (1+Rt)} x Ee Where Et = spot exchange rate ($/€) consistent with interest rate parity for given values of R€ and Ee 1 + R€ = gross return on foreign deposits 1 + Rt = gross return on domestic deposits right now Ee = exchange rate ($/€) expected in future Note the inverse relation between Et and Rt
