If the forward rate is expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then:
A) covered interest arbitrage is feasible.
B) the international Fisher effect (IFE) is supported.
C) the international Fisher effect (IFE) is refuted.
D) the average absolute error from forecasting would equal zero.

Question

If the forward rate is expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then:​
A) ​covered interest arbitrage is feasible.
B) ​the international Fisher effect (IFE) is supported.
C) ​the international Fisher effect (IFE) is refuted.
D) ​the average absolute error from forecasting would equal zero.

Quizplus · Accepted Answer

The international Fisher effect (IFE) states that the difference in the nominal interest rates between two countries is equal to the expected change in the exchange rate between those countries. If the forward rate is an unbiased estimate of the future spot rate and interest rate parity holds, then the IFE is supported. So, option B is correct. Covered interest arbitrage is not feasible if interest rate parity holds as it eliminates any profit opportunities. Therefore, option A is incorrect. The average absolute error from forecasting may not equal zero as there could be unexpected events that impact exchange rates. Therefore, option D is incorrect.

If the Forward Rate Is Expected to Be an Unbiased