The transformation calculator
Most tools show you the foreign yield and stop. That number is the seductive one and it is almost always the wrong one. This shows you what is underneath it, and the gaps between those numbers are the thing you are actually deciding about.
Covered interest parity is not a theory, it is an arbitrage condition that holds to within the cross-currency basis. The forward price of a currency is set by the interest rate difference between the two currencies. So if you buy a foreign currency spot to earn its higher rate, and sell it forward to remove the currency risk, the forward price has already charged you almost exactly the extra yield you went to collect.
F / S = (1 + r_foreign * t) / (1 + r_domestic * t)
with the cross-currency basis b:
F / S = (1 + (r_foreign + b) * t) / (1 + r_domestic * t)Rearranged into plain language: your hedged return is roughly your own home rate, plus the basis, minus what it cost you to trade. It is not the foreign rate. The foreign rate cancels. Anyone selling you a currency trip on the strength of the headline yield is either not hedging, which means they are taking currency risk they have not named, or they have not done this arithmetic.
Bid to offer on a retail or small-institutional currency conversion runs somewhere between 50 and 200 basis points per leg, and a round trip is two legs. On a one-year holding period that is frequently larger than the entire yield difference being chased. The calculator lets you set it, because it is the number that most often turns a yes into a no.
It does not price your credit risk, your smart contract risk, your issuer risk or your redemption risk, and several of the instruments in this index carry a great deal of all four. It prices the currency decision only. Read the instrument page before you act on any of it.