Part II Marks 60 1. Which of the following statements is correct regarding the c

Question

Part II Marks 60 1. Which of the following statements is correct regarding the covered interest parity condition? A: Spot and forward exchange rates tend to diverge, in general, to be precisely in line B: The domestic interest rate must be higher or lower than the foreign interest rate by C: The domestic interest rate must be lower (higher) than the foreign interest rate by D: All of the above statements are correct E: A and C are correct with the interest differential. the extent the domestic currency is anticipated to depreciate or appreciate. the extent the domestic currency sells at a discount (premium).

Explanation / Answer

As per interest rate parity theory, the interest rates and the spot and forward rates of two contries are in equilibrium. Hence, as per this theory, spot and forward rates in two countries tend to change with the change in interest rates in those countires. If the domestic interest rate increases then the domestic currency with respect to foreign currency rate tends to appreciates in the same pace and if the domestic interest rate decreases, then the domestic currency rate with respect to foreign currency tends to depreciate in the same pace.

Hence, all the given statements are correct.

So, the answer is D. All of the above statements are correct.

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