For both reasons, the forward discount on the dm will tend to increase, pushing it up to the interest rate differential. Under normal conditions, the relationship between spot and forward rates is determined largely by covered interest arbitrage. However, this may not hold even approximately when covered interest arbitrage is forbidden or with large destabilizing speculation. Speculation Foreign exchange speculation is the act of taking a foreign exchange risk or an uncovered position in hopes of marking a profit. It is the opposite of hedging.
Speculators influence the demand side of the foreign exchange markets.
A foreign exchange speculator who expects the spot rate of a foreign currency to be higher in three months could purchase the currency in the spot market today at today's spot rate, hold it for three months, and then resell it for the domestic currency in the spot market after three months. On the other hand, if the speculator expects the spot rate of a foreign currency to be lower in three months, he can borrow the foreign currency and exchange it for the national currency at today's spot rate. Foreign exchange speculation usually takes place in the forward market because it is simpler and, at the same time, involves no borrowing of the foreign currency or tying up of the speculator's funds.