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:

Local Governments

Administrative bodies governing smaller geographical areas within a country, responsible for local policies and regulations, typically including cities or counties.

Sales Taxes

Taxes imposed by governments on the sale of goods and services.

Regressive

A type of tax system in which the tax rate decreases as the taxable amount increases, often placing a higher burden on lower-income earners.

Inelastic Supply

A situation where the supply of a good does not significantly change when its price changes, often due to limitations in production capabilities or time constraints.