Assume that the U.S. interest rate is 10 percent, while the British interest rate is 15 percent. If interest rate parity exists, then:
A) British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the United States.
B) U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the United States.
C) U.S. investors will earn 15 percent whether they use covered interest arbitrage or invest in the United States.
D) U.S. investors will earn 10 percent whether they use covered interest arbitrage or invest in the United States.

Question

​Assume that the U.S. interest rate is 10 percent, while the British interest rate is 15 percent. If interest rate parity exists, then:
A) ​British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the United States.
B) ​U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the United States.
C) ​U.S. investors will earn 15 percent whether they use covered interest arbitrage or invest in the United States.
D) ​U.S. investors will earn 10 percent whether they use covered interest arbitrage or invest in the United States.

Quizplus · Accepted Answer

Interest rate parity ensures that investors will earn the same return on investments in different countries once hedging against exchange rate risk is accounted for. Thus, U.S. investors using covered interest arbitrage to invest in the UK would still earn the equivalent of the U.S. interest rate of 10 percent, after adjusting for the cost of hedging against currency risk.

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