Question

The interplay between interest rate differentials and exchange rates, such that each adjusts until the foreign exchange market and the money market reach equilibrium, is called the

A. Purchasing Power Parity Theory.
B. Balance of Payments.
C. Interest Rate Parity Theory.
D. None of the options are correct.

Answer 1

The interplay between interest rate differentials and exchange rates, such that each adjusts until the foreign exchange market and the money market reach equilibrium, is called the C)Interest Rate Parity Theory.

Step-by-step explanation:

The correct answer is C. Interest Rate Parity Theory. Interest rate parity theory explains the relationship between interest rates and exchange rates. According to this theory, the interest rate differential between two countries will be equal to the percentage difference between the forward exchange rate and the spot exchange rate. The adjustment of interest rates and exchange rates occurs until both the foreign exchange market and the money market reach equilibrium.