If the difference between forward and spot exchange rates is positive, interest rate parity would predict that:
A)The difference in interest rates between countries will be negative
B)The difference in interest rates between countries will be positive
C)There will be no difference in interest rates between countries
D)The difference will be quickly eliminated

Question

Quizplus · Accepted Answer

Interest rate parity predicts that the forward exchange rate should equal the spot exchange rate adjusted for the difference in interest rates between the two countries. If the difference between forward and spot exchange rates is positive, it suggests that the forward exchange rate is trading at a premium to the spot exchange rate. This implies that the currency with the higher interest rate is expected to appreciate in value over time. To eliminate the potential for arbitrage, the interest rate differential must be positive to offset the forward premium for the currency with the higher interest rate. Therefore, interest rate parity predicts that the difference in interest rates between countries will be positive.

If the Difference Between Forward and Spot Exchange Rates Is