If the expected proportionate change in the nominal exchange rate, measured in units of domestic currency per unit of foreign currency, is 2 percent and the domestic interest rate is 6 percent, then according to the uncovered interest parity condition, the foreign interest rate should be equal to:
A) 6 percent × 2 percent = 12 percent.
B) 6 percent + 2 percent = 8 percent.
C) 6 percent - 2 percent = 4 percent.
D) 6 percent ÷ 2 percent = 3 percent.

Question

Quizplus · Accepted Answer

According to the uncovered interest parity condition, the expected proportionate change in the nominal exchange rate equals the difference between the foreign and domestic interest rates. Therefore, we can solve for the foreign interest rate as follows:

Expected change in exchange rate = Foreign interest rate - Domestic interest rate
2% = Foreign interest rate - 6%
Foreign interest rate = 6% + 2% = 8%

Therefore, the foreign interest rate should be 8%. The correct answer is choice (B).

If the Expected Proportionate Change in the Nominal Exchange Rate