Describe the implications of the interest rate parity for the exchange rate determination.
Supposing that the forward exchange rate is roughly unbiased predictor of the future spot rate, IRP can be written as following:
S = [(1 + I£)/(1 + I$)]E[St+1It].
Thus the exchange rate is determined through the relative interest rates, & the expected future spot rate, conditional on all the obtainable information, It, as of the current time. One therefore can say that expectation is self-fulfilling. As the information set will be continuously updated as news hit the market, the exchange rate will exhibit extremely dynamic, random behaviour.