The principle of interest rate parity asserts that the:
A) relative spot exchange rates determine the relativity between the forward exchange rates and spot rates.
B) relativity between spot and forward exchange rates reflects the interest rate differentials between countries.
C) relative forward exchange rates determine the relativity between the spot exchange rates and the forward interest rate.
D) relative forward exchange rates determine the relativity between the forward exchange rates and forward interest rates.

Question

Quizplus · Accepted Answer

The principle of interest rate parity states that the difference in interest rates between two countries will determine the relative value of their currencies in the future. This means that the exchange rate for two currencies is determined by the difference in interest rates between the countries they belong to. Therefore, the relativity between spot and forward exchange rates reflects the interest rate differentials between countries. A is incorrect because it refers to spot exchange rates determining the forward exchange rates, which is not true according to the interest rate parity principle. C and D are also incorrect as they reverse the cause-and-effect relationship between interest rates and exchange rates described by the principle of interest rate parity.

The Principle of Interest Rate Parity Asserts That The