Assume that interest rate parity holds. The U.S. one-year interest rate is 10 percent, and the Australian one-year interest rate is 8 percent. What will the approximate effective yield of a one-year deposit denominated in U.S. dollars be for an Australian citizen? (Assume the deposit is covered by a forward sale of dollars.)

Question

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Interest rate parity suggests that the difference in interest rates between two countries is offset by the forward exchange rate. Thus, an Australian citizen would earn the Australian interest rate of 8 percent when the deposit is covered by a forward sale of dollars.

Assume That Interest Rate Parity Holds