If interest rate parity holds,
A)covered interest arbitrage opportunities will exist.
B)covered interest arbitrage opportunities will not exist.
C)arbitragers will be able to make risk-free profits.
D)covered interest arbitrage opportunities will exist, and arbitragers will be able to make risk-free profits.

Question

Quizplus · Accepted Answer

With interest rate parity holding, the exchange rate between two currencies should be equal to the ratio of their respective interest rates. Therefore, there will be no covered interest arbitrage opportunities available as the forward exchange rates will be equal to the expected future spot rates, and the interest rate differential between two countries will be reflected in their respective currencies' forward rates. Hence, neither arbitrageurs can make any risk-free profits nor will any covered interest arbitrage opportunities be present.

If Interest Rate Parity Holds