If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing rate will be ____ the home financing rate.
A) lower than
B) greater than
C) similar to
D) None of these are correct.

Question

Quizplus · Accepted Answer

If interest rate parity exists and the forward rate is an accurate estimator of the future spot rate, then the foreign financing rate should be similar to the home financing rate. This is because interest rate parity suggests that, in the absence of arbitrage opportunities, the interest rate differential between two countries should be equal to the percentage difference between the forward exchange rate and the spot exchange rate. Therefore, if the forward rate is an accurate predictor of the future spot rate, the interest rate differential should be offset by changes in the exchange rate, resulting in similar financing rates between the two countries.

If Interest Rate Parity Exists, and the Forward Rate Is