If interest rate parity exists,the attempt to finance with a foreign currency while covering the position to avoid exchang rate risk will result in an effective financing rate that is _________ the domestic interest rate.
A) lower than
B) greater than
C) similar to
D) none of the above

Question

Quizplus · Accepted Answer

Interest rate parity states that the difference in interest rates between two countries should be equal to the percentage difference between the forward exchange rate and the spot exchange rate. This means that if a company finances with a foreign currency, it will have to pay a higher interest rate on that currency due to the risk of exchange rate fluctuations. However, it should also receive a corresponding benefit from the expected appreciation of the foreign currency. When these two factors are taken into account, the effective financing rate should be similar to the domestic interest rate.

If Interest Rate Parity Exists,the Attempt to Finance with a Foreign