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Covered interest rate parity (CIRP) is an economic theory that suggests that the forward exchange rate should incorporate the interest rate differential between two countries. According to CIRP, if two countries have different interest rates, then the currency of the country with the higher interest rate should be expected to depreciate in value in the future.
However, in practice, CIRP does not always hold. There are various reasons for this, such as transaction costs, government regulations, and market frictions. In addition, there are certain financial instruments and strategies that can be used to exploit deviations from CIRP, which can further undermine the theory.
Despite these challenges, CIRP remains an important concept in international finance and is often used as a benchmark for evaluating the effectiveness of foreign exchange markets.
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