Uncovered interest arbitrage

Unlike covered interest arbitrage, uncovered interest arbitrage involves no hedging of foreign exchange risk with the use of forward contracts or any other contract.

When a discrepancy between these occurs, investors who are willing to take on risk will not be indifferent between the two possible locations of investment, and will invest in whichever currency is expected to offer a higher rate of return including currency exchange gains or losses (perhaps adjusted for a risk premium).

[4] An arbitrageur executes an uncovered interest arbitrage strategy by exchanging domestic currency for foreign currency at the current spot exchange rate, then investing the foreign currency at the foreign interest rate, and at the end of the investment term using the spot foreign exchange market to convert back to the original currency.

[5][6] The risk arises from the fact that the future spot exchange rate for the currencies is not known with certainty when the strategy is chosen.

Investing US$5,000,000 domestically at 3.4% for six months ignoring compounding, will result in a future value of US$5,170,000.