The following information is given, where the exchange rates are quoted indirect

Question

The following information is given, where the exchange rates are quoted indirectly: a spot rate of S = US$0.86/A$, a one year forward rate of F = US$0.84/A$, a one year domestic interest rate of r = 0.05 (= 5%) and a one year foreign rate of r* = 0.03 (= 3%) and the interest rate parity relationship

Given the above information we can determine that:

a) interest parity holds b) the interest rate differential is exactly offset by the exchange rate differential c) interest parity does not hold and the exchange rate differential is greater than the interest rate differential d) interest parity does not hold and the interest rate differential is greater than the exchange rate differential

Explanation / Answer

Option "C" is correct, i.e.,

interest parity does not hold and the exchange rate differential is greater than the interest rate differential

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