Exam 15: Exchange Rates, Interest Rates, and Interest Parity

Nominal interest rates tend to be higher in countries with

We can expect very small deviations from interest rate parity in

The interest parity condition indicates that the interest differential is equal to the

There are several reasons why interest rate parity may not hold exactly and, therefore, we can earn arbitrage profits from this situation.

If real interest rates are equal in two countries, then the nominal interest differential on their currencies will equal

In order to infer expected future exchange rates, we must have a forward exchange market in a currency.

Suppose that the forward rate of Mexican pesos per dollar is selling flat, with both the spot and forward rates trading at 15 pesos per dollar. If the relevant interest rates for a foreign exchange speculator are 3 percent on dollars and 13 percent in pesos, a potential arbitrage operation would involve

Interest rate parity is more likely to hold in the short run than purchasing power parity.

If the nominal interest rate is 5.6 percent and the rate of inflation is 7.1 percent in a given year, then what is the corresponding real rate of return?

Write down the Fisher equation and IRP relationship for the United States and the United Kingdom. Using these relationships, how can we determine the link between interest, inflation, and exchange rates? How can a change in U.S. policy affect this link?

The effective return from a foreign investment is

When one country has higher nominal interest rates than another country, the high-interest- rate currency is expected to relative to the low-interest-rate currency.

How has the globalization of financial markets affected the way in which countries conduct their economic policies?

Deviations from interest rate parity could be due to transaction costs, differential taxation, government controls, and political risk.

Arbitrage opportunities exist when uncovered interest rate parity does not hold.

The relationship that implies that the nominal interest rate is equal to the real interest rate plus expected inflation is called the

Money is more mobile geographically now than in the past.

If the real rate of interest is the same internationally, then the nominal interest rates differ solely by the expected inflation differential in two countries.

Interest rate parity holds well in the Eurocurrency market.

The term structure relationships regarding different interest rates approximately reflect expected exchange rate changes.