Uncovered interest arbitrage is a form of arbitrage that involves switching from a domestic currency that carries a lower interest rate to a foreign currency that offers a higher rate of interest on deposits. There is a foreign exchange risk implicit in this transaction since the investor or speculator will need to convert the foreign currency deposit proceeds back into the domestic currency some time in the future. The term uncovered in this arbitrage refers to the fact that this foreign exchange risk is not covered through a forward or futures contract.
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