If interest rate parity exists, transactions costs are zero, and the forward rate is an accurate predictor of the future spot rate, then the effective financing rate on a foreign currency:
A) would be equal to the U.S. interest rate.
B) would be less than the U.S. interest rate.
C) would be more than the U.S. financing rate.
D) would be less than the U.S. interest rate if the forward rate exhibited a discount and more than the U.S. interest rate of the forward rate exhibited a premium.

Question

Quizplus · Accepted Answer

If interest rate parity exists and transactions costs are zero, then the effective financing rate on a foreign currency should be equal to the domestic interest rate. The accurate predictor of the future spot rate (which is assumed to be the forward rate) does not affect this relationship. Therefore, the effective financing rate on a foreign currency would be equal to the U.S. interest rate.

If Interest Rate Parity Exists, Transactions Costs Are Zero, and the Forward