Assume That Interest Rate Parity Exists, and There Are Zero

question 14

Multiple Choice

Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate consistently underestimates the future spot rate, then:

• A) on average, the foreign effective financing rate is greater than the domestic interest rate.
• B) on average, the foreign effective financing rate is less than the domestic rate.
• C) the foreign effective financing rate exceeds the U.S. interest rate when its forward rate exhibits a discount and is less than the U.S. interest rate when its forward rate exhibits a premium.
• D) the foreign effective financing rate is less than the U.S. interest rate when its forward rate exhibits a discount and exceeds the U.S. interest rate when its forward rate exhibits a discount.

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Definitions:

Frequency of Association

A concept in psychology referring to how often two ideas, words, or concepts are linked together in a person's memory, affecting the ease of recall or recognition.

Encoding Specificity

The principle that recall is more effective if the context at the time of encoding matches the context at the time of retrieval.

Cognitive Economy

A principle in cognitive psychology that suggests the brain strives to simplify information processing by using the most efficient and simplest ways to understand and process information.

Spreading Activation

A theory in cognitive psychology that suggests ideas in memory are connected and that the activation of one idea can trigger the activation of related ideas.