In equilibrium, if both uncovered and covered interest parity hold, what condition should exist?
A) World interest rates will be equal.
B) Rates of inflation will equalize.
C) The forward rate will equal the expected future spot rate.
D) The forward rate will decrease as the spot rate rises.

Question

Quizplus · Accepted Answer

If both uncovered and covered interest parity hold, it implies that there are no arbitrage opportunities and that exchange rates are in equilibrium. In this situation, the forward rate will equal the expected future spot rate, which means that investors are indifferent between investing in domestic or foreign currencies. Therefore, option C is the correct choice. Option A may not necessarily be true as interest rate differentials could exist to compensate for differences in risk. Option B does not have a direct relationship with interest parity, and option D is incorrect as it suggests a violation of interest parity.

In Equilibrium, If Both Uncovered and Covered Interest Parity Hold