One theory that is useful states that the forward premium ordiscount should be e
ID: 2661912 • Letter: O
Question
One theory that is useful states that the forward premium ordiscount should be equal and opposite in sign to the difference inthe national interest rates for securities of the same maturity.This theory is known as:a. the forward rate theory b. the interest rate parity theory c. the exchange rate theory d. the covered interest arbitrage theory One theory that is useful states that the forward premium ordiscount should be equal and opposite in sign to the difference inthe national interest rates for securities of the same maturity.This theory is known as:
a. the forward rate theory b. the interest rate parity theory c. the exchange rate theory d. the covered interest arbitrage theory
Explanation / Answer
b. the interest rate paritytheory The discount rate often used incapital budgeting that makes the net present value of all cashflows from a particular project equal to zero. Generallyspeaking, the higher a project's internal rate of return, the moredesirable it is to undertake the project. As such, IRR can be usedto rank several prospective projects a firm is considering.Assuming all other factors are equal among the various projects,the project with the highest IRR would probably be considered thebest and undertaken first. IRR is sometimes referred to as "economic rate of return(ERR)". You can think of IRR as the rate of growth a project isexpected to generate. While the actual rate of return that agiven project ends up generating will often differ from itsestimated IRR rate, a project with a substantially higher IRR valuethan other available options would still provide a much betterchance of strong growth. IRRs can also be compared against prevailing rates of return in thesecurities market. If a firm can't find any projects with IRRsgreater than the returns that can be generated in the financialmarkets, it may simply choose to invest its retained earnings intothe market.
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