Question

Arbitragers applying Covered Interest Arbitrage drive the international currency and money markets toward the equilibrium described by: Select one: a. the nominal effective exchange rate index. b. the interest rate parity. c. the purchasing power parity. d. the effective exchange rate index.

Answer 1

The correct answer is letter "B": the interest rate parity.

Step-by-step explanation:

The economic theory of Interest Rate Parity (IRP) states that the difference between interest rates in the two countries is equal to the difference between the forward rate and the spot rate in both countries. This equality does not always exist and allows traders to arbitrate positions to earn riskless returns. This approach is mostly used by Forex traders.