Interest rate parity means that
A)in equilibrium, interest rates adjust so that after adjustments for expected inflation and exchange rate risk, returns are equalized across countries.
B)nominal interest rates tend to become equalized across countries over time.
C)an inflation premium is added to nominal interest rates to insure purchasing power parity across countries.
D)None of the above.

Question

Quizplus · Accepted Answer

Interest rate parity refers to the equilibrium condition in which interest rates are adjusted so that after adjusting for expected inflation and exchange rate risk, the returns are equalized across countries. This means that investors should be indifferent between investing in different currencies because they will earn the same return regardless of the currency they choose. This concept is based on the idea that arbitrage opportunities will arise if the returns are not equalized, leading to an adjustment in interest rates until parity is achieved.

Interest Rate Parity Means That