If interest rate parity exists and the forward rate is expected to overestimate the future spot rate, then uncovered foreign financing is expected to result in an effective financing rate that will be:
A) similar to the U.S. financing rate.
B) lower than the U.S. financing rate.
C) higher than the U.S. financing rate.
D) lower than the U.S. interest rate if the forward rate exhibits a discount and higher than the U.S. interest rate if the forward rate exhibits a premium.

Question

​If interest rate parity exists and the forward rate is expected to overestimate the future spot rate, then uncovered foreign financing is expected to result in an effective financing rate that will be:
A) ​similar to the U.S. financing rate.
B) ​lower than the U.S. financing rate.
C) ​higher than the U.S. financing rate.
D) ​lower than the U.S. interest rate if the forward rate exhibits a discount and higher than the U.S. interest rate if the forward rate exhibits a premium.

Quizplus · Accepted Answer

If the forward rate overestimates the future spot rate, the foreign currency will depreciate less than expected, leading to a lower effective financing rate compared to the U.S. rate.

​If Interest Rate Parity Exists and the Forward Rate Is

If Interest Rate Parity Exists and the Forward Rate Is