Question

1. What action ensures that interest rate parity holds?

2. What is the difference between a Eurodollar and a Eurocurrency? What interest rate is tied to Eurodollars?

3. List two strategies a company can use to reduce the potential loss from expropriation.

Answer 1

(1): As per the interest rate parity the interest rate differential between two countries is the same as the differential between the forward exchange rate and the spot exchange rate. The action that ensures that interest rate parity holds is the action of keeping the bank deposits and government bonds of a country truly risk free in nature. When this is the case the parity holds perfectly in real life as it does in theory.

(2): Eurodollar is the type of bonds issued by companies in US dollars but outside USA. These bonds are called Eurodollars as historically they were issued primarily in Europe. In other words Eurodollars are time deposits denominated in U.S. dollars at banks outside USA. On the other hand Eurocurrency is the currency deposited by national governments or corporations in banks outside their home market.

The interest rate that is attached to Eurodollar is the fed funds rate for deposits ranging from overnight to a week. In case of deposits of longer maturities the interest rate that is attached is the corresponding LIBOR (London Interbank Offered Rate).

(3): Two strategies that companies can use to reduce the potential loss from expropriation are: (i) By making use of stabilization clauses as per Economic Development Agreements (EDA). Guarantees and protections provided in the Bilateral Investment Treaty (BIT) can also be used. (ii) Including several interrelated protections in its contracts with the host government so as to maximize its chances of recovering loss.