Chartered Financial Analyst Level 1

Let S be the spot exchange rate quoted as domestic currency per unit of foreign currency (DC/FC). Covered interest rate parity gives the forward rate F as:

F = S * (1 + r_dom) / (1 + r_for)

where r_dom is the domestic risk-free rate and r_for is the foreign risk-free rate. If the foreign risk-free interest rate (r_for) increases, the denominator (1 + r_for) rises, causing F to fall, all else equal. Thus an increase in the foreign risk-free interest rate leads to a decrease in the forward exchange rate. Intuitively: higher foreign interest rates make holding foreign currency assets more attractive, so the forward price (domestic currency price of foreign currency) adjusts downward.*