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You explained that both inflation and interest rates can influence exchange rates, buy why do we strictly use interest rates parity to determine forward exchange rates?
Is it because it’s the bank that makes the profit on the forward transaction?
As I explain in the lecture, the banks have lots of customers wanting forward rates. The bank ‘pools’ all the customers money together and uses money market hedging on the total money.
The banks will certainly charge for the service, but subject to that forward rates and money market hedging (which is purely based on relative interest rates) would come to exactly the same result in real life.
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