A firm that buys foreign exchange in order to take advantage of higher foreign interest rates is
A)speculating.
B)demonstrating purchasing power parity.
C)engaging in interest rate arbitrage.
D)responding to fluctuations in the business cycle.
E)ignoring the nominal rate of exchange.

Question

Quizplus · Accepted Answer

Engaging in interest rate arbitrage involves taking advantage of the difference in interest rates between two countries by buying foreign exchange in order to invest in higher interest rate countries. This is a form of financial speculation, but it is specifically focused on interest rate differentials and is not related to purchasing power parity or fluctuations in the business cycle. Additionally, it does not involve ignoring the nominal rate of exchange as it is a key factor in determining the profitability of the arbitrage opportunity.

A Firm That Buys Foreign Exchange in Order to Take