Which of the following statements is most valid?
A)The forward exchange rate is higher than the spot exchange rate if the foreign currency risk premium is positive.
B)The currency that pays a higher interest rate trades at a premium in the forward exchange market.
C)The currency that pays a higher interest rate trades at a discount in the forward exchange market.
D)Whether the forward exchange rate is higher than the spot depends on the relative volatilities of interest rates in the two currencies.

Question

Quizplus · Accepted Answer

The currency that pays a higher discount rate trades at a discount because covered interest parity between the two currencies requires that the one that earns more interest suffers a relative capital loss in the forward exchange market.The forward exchange rate does not directly depend on the risk premium or interest-rate volatilities,these values are already accounted for by the spot exchange rate and interest-rate levels that are used to determine the forward exchange rate.

Which of the Following Statements Is Most Valid