Interest Rate Parity theory states that interest rates must be the same in all countries using floating exchange rates or else international markets will not be in equilibrium.
Interest rate parity theory states that the forward premium or discount should be equal and opposite in sign to the difference in the national interest rates for securities of the same maturity.
Suppose the 360-day forward exchange rate is 1.657 dollars per British pound,and the current spot rate is 1.625 dollars per British pound.If the 360-day interest rate in the United States is 5% and the 360-day interest rate in Great Britain is 3%,is the market in equilibrium according to the interest rate parity theory? A) Yes, because the forward premium on the pound (2%) is exactly offset by the lower interest rate in Great Britain. B) No, because the higher interest rate in the United States (2%) implies that the forward exchange rate should be 2% lower than the current spot rate. C) No, because the forward premium on the pound is 2% while the interest rate in the United States is 67% higher than the interest rate in Great Britain. D) Cannot be determined without knowing the amount of money being exchanged.
Money-market hedges and forward-market hedges rely on the A) interest rate parity theory. B) purchasing power parity theory. C) law of large numbers. D) capital asset pricing model.