Lapses in interest rate parity are a good way to make money, but uncovered interest rate parity is risky.
Uncovered interest rate parity refers to fact that the difference between two countries' interest rates and their current and expected current values will tend to be similar or equal.
Expected vs. Forward
A forward exchange rate is an agreement to pay a specific amount for a currency at a specific time in the future. It is therefore concrete. An expected exchange rate, on the other hand, is an estimate that is subject to change.
Opportunities for Arbitrage
If one country's interest rates are five percent and another country's are eight percent (difference of three), and both the expected and current foreign exchange rates are 1:1 (difference of zero), then interest rate parity does not exist. Someone can borrow money at five percent, exchange it, then lend it at eight percent for a three-percent profit. When people do this, it increases supply and demand of the four values involved, which makes them regress back towards parity.
Risks
The risk in uncovered interest rate parity is that it is based on an estimate. If you expect a currency to be equal to yours in a year, like in the example above, but it drops by 10 percent, then you have lost 10 percent of your initial investment. This means that the three-percent profit turns into a seven-percent loss.
