Currency Derivatives: The Gap Arbitrage Was Supposed to Close
Covered interest rate parity says a currency's forward rate is pure arithmetic — spot, adjusted for the interest-rate gap between two currencies, nothing more.
Covered interest rate parity says a currency's forward rate is pure arithmetic — spot, adjusted for the interest-rate gap between two currencies, nothing more. Since 2008, the actual market price has quietly disagreed, by an amount called the cross-currency basis. What FX forwards, FX swaps, cross-currency swaps and currency options actually are, why that gap should have been arbitraged away and wasn't, and why it blows widest open exactly when a country needs dollar funding most — with paired Indian and international examples throughout.
Surya · 9 min read