Question

Suppose the pound's forward rate exhibits a percentage discount that is exactly equal to the amount by which the pound's interest rate rate exceeds the home currency rate. From a trader's viewpoint, covered interest arbitrage is not possible in this case. Question 15 options: a) True b) False Question 16 (1 point) The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity. (IRP) Question 16 options: a) True b) False Question 17 (1 point) If interest rate parity exists, then the expected rate of return from a long term investment denominated in a foreign currency is the same as the expected rate of return of an investment denominated in the local currency. Question 17 options: a) True b) False Question 18 (1 point) Interest rate parity (IRP) states that foreign currency's forward premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country. Question 18 options: a) True b) False

Answer 1

Suppose the pound's forward rate exhibits a percentage discount that is exactly equal to the amount by which the pound's interest rate rate exceeds the home currency rate. From a trader's viewpoint, covered interest arbitrage is not possible in this case. Question 15 options: a) True b) False

Covered interest arbitrage is a trading strategy in which the investor expects the exchange rate differential between 2 currencies to be different from the interest rate difference between the respective markets. Here as the currency movement is equal to the interest rate movement, there is no opportunity for the trader to exploit. Thus covered interest rate arbitrage is not possible. 15 answer is a) true

Question 16 (1 point) The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity. (IRP) Question 16 options: a) True b) False

Yes. Interest rate parity is defined as a condition where no arbitrage opportunities exists i.e a equilibrium state in which the investor is indifferent to the interest rates available in either countries as the currency movement will be inline with the interest rate movement. 16. Answer is a) True

Question 17 (1 point) If interest rate parity exists, then the expected rate of return from a long term investment denominated in a foreign currency is the same as the expected rate of return of an investment denominated in the local currency. Question 17 options: a) True b) False

Yes. A return of long term investment in foreign currency, when converted back to domestic currency after the period of investment will be equal to what would be earned had the same fund was invested in home country if the interest rate parity exists (movement in currency betwen 2 countries equal to interest rate movement between 2 countries). Thus 17. Answer is a) true

Question 18 (1 point) Interest rate parity (IRP) states that foreign currency's forward premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country. Question 18 options: a) True b) False

Yes. Interest rate parity is defined as a no arbitrage situation where the interest rate differential between 2 countries is equal to the differential between the forward and spot exchange rate between the 2 countries. Thus by definition, forward premium or discount should be equal to interest rate differential. 18. Answer is a) true