Question

If interest rate parity holds, the currency of the country with the relatively _______ interest rates will trade at a forward _______ to the country with the relatively _______ interest rate. Select one: a. high; premium; low b. low; discount; high c. high; discount; low d. None of the given choices

Answer 1

The correct answer is c. high; discount; low, which reflects the relationship described by interest rate parity where higher interest rates correspond to a currency trading at a forward discount relative to a country with lower interest rates.

Step-by-step explanation:

If interest rate parity holds, the currency of the country with the relatively higher interest rates will trade at a forward discount to the country with the relatively lower interest rate. Therefore, the correct answer is c. high; discount; low.

Under the condition of interest rate parity, the difference between the interest rates of two countries reflects the expected change in the exchange rates between the two countries' currencies. If one country has higher interest rates than another, investors will want to invest in that country to get higher returns. To avoid arbitrage opportunities, the currency of the country with higher interest rates must trade at a discount in the forward exchange rate market, so that when the maturity date of the investment is reached, the potential benefit from the interest rate differential is offset by the difference in spot and forward rates, maintaining equilibrium.