Assume that interest rate parity holds. The U.S. interest rate is 13 percent and the British interest rate is 10 percent. The forward rate on British pounds exhibits a ____ of ____ percent.
A) discount; 2.73
B) premium; 2.73
C) discount; 3.65
D) premium; 3.65

Question

Assume that interest rate parity holds. The U.S. interest rate is 13 percent and the British interest rate is 10 percent. The forward rate on British pounds exhibits a ____ of ____ percent.​
A) ​discount; 2.73
B) ​premium; 2.73
C) ​discount; 3.65
D) ​premium; 3.65

Quizplus · Accepted Answer

When interest rate parity holds, the currency of the country with the higher interest rate (in this case, the U.S.) will trade at a forward discount relative to the currency of the country with the lower interest rate (Britain). However, the given answer choice indicates a premium, which means there's an inconsistency in the explanation. According to interest rate parity, the forward rate should indeed reflect a discount for the British pound if U.S. rates are higher. The correct explanation should note that the forward rate discrepancy (premium or discount) is determined by the interest rate differential. However, without the specific formula or calculation provided in the options, the direct application of interest rate parity principles would suggest a discount for the pound, not a premium. This indicates a mistake in the initial explanation provided. The correct approach to determine the exact premium or discount percentage involves using the interest rate differential and the formula for calculating forward rate premiums or discounts, which is not explicitly done in the provided answer choices.

Assume That Interest Rate Parity Holds