depends on three known variables: the spot exchange rate, the domestic interest rate, and the foreign interest rate. This effectively means that the forward rate is the price of a forward contract, which derives its value from the pricing of spot contracts and the addition of information on available interest rates. The following equation represents covered interest rate parity, a condition under which investors eliminate exposure to foreign exchange risk (unanticipated changes in exchange rates) with the use of a forward contract – the exchange rate risk is effectively covered. Under this condition, a domestic investor would earn equal returns from investing in domestic assets or converting currency at the spot exchange rate, investing in foreign currency assets in a country with a different interest rate, and exchanging the foreign currency for domestic currency at the negotiated forward exchange rate. Investors will be indifferent to the interest rates on deposits in these countries due to the equilibrium resulting from the forward exchange rate. The condition allows for no arbitrage opportunities because the return on domestic deposits, 1+id, is equal to the return on foreign deposits, [F/S](1+if). If these two returns weren't equalized by the use of a forward contract, there would be a potential arbitrage opportunity in which, for example, an investor could borrow currency in the country with the lower interest rate, convert to the foreign currency at today's spot exchange rate, and invest in the foreign country with the higher interest rate. where F is the forward exchange rate S is the current spot exchange rate id is the interest rate in domestic currency (base currency) if is the interest rate in foreign currency (quoted currency) This equation can be arranged such that it solves for the forward rate: Forward premium or discount The equilibrium that results from the relationship between forward and spot exchange rates within the context of covered interest rate parity is responsible for eliminating or correcting for market inefficiencies that would create potential for arbitrage profits. As such, arbitrage opportunities are fleeting. In order for this equilibrium to hold under differences in interest rates between two countries, the forward exchange rate must generally differ from the spot exchange rate, such that a no-arbitrage condition is sustained. Therefore, the forward rate is said to contain a premium or discount, reflecting the interest rate differential between two countries. The following equations demonstrate how the forward premium