This equation is Interest Rate Parity rearranged! If the term on the left (1 + rDC), is less than the term on the right, it means that the domestic rate is low relative to the hedged foreign rate. Therefore, there is a profitable arbitrage from borrowing the domestic currency and lending at the foreign interest rate. Because we lend in the foreign market, we say that the funds flow out of the domestic economy.
(Study Session 4, LOS 14.e) |
