If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate.
A) lower than
B) greater than
C) similar to
D) none of the above

Question

Quizplus · Accepted Answer

If interest rate parity exists, the forward exchange rate will adjust such that the overall cost of borrowing is the same regardless of the currency in which the borrowing is done. Therefore, the effective financing rate will be similar to the domestic interest rate, as there will be no advantage or disadvantage to borrowing in a foreign currency.

If Interest Rate Parity Exists, the Attempt to Finance with a Foreign