# A B C D E F G H I J K L M N O P Q R S T U V W X Y Z

Net Interest Rate Differential

Written By
Paul Tracy
Updated January 16, 2021

What is the Net Interest Rate Differential?

Net interest rate differential is the difference in interest rates associated with two different currencies or two different economic regions.

How Does the Net Interest Rate Differential Work?

For example, let's assume an investor in Japan puts her Japanese savings in a Japanese bank and earns interest at Japanese interest rates (say 8%). Let's further assume that this investor then borrows money from an American bank and the loan is denominated in U.S. dollars. Because loans happen to be cheap in the U.S. at the time, the investor pays 6% on the loan. Now the investor can take advantage of the net interest rate differential by borrowing at 6% and putting in a Japanese bank to earn 8%, for a tidy 2% profit.

Why Does the Net Interest Rate Differential Matter?

The net interest rate differential is a fundamental component of the interest rate parity theory, whereby the difference in interest rates between two countries equals the difference between the current and expected exchange rates between the two currencies. As a result, the net interest rate differential is a key factor in pricing currency forward contracts.

Ask an Expert about Net Interest Rate Differential
At InvestingAnswers, all of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Net Interest Rate Differential.
Be the first to ask a question

If you have a question about Net Interest Rate Differential, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about Net Interest Rate Differential, then please ask Paul.

Ask a question Read more from Paul

Read this next

Paul Tracy - profile
Ask an Expert about Net Interest Rate Differential

By submitting this form you agree with our Privacy Policy

Share
close
Don't Know a Financial Term?
Search our library of 4,000+ terms