If U.S.interest rates are expected to be 6 percent next year, European interest rates are expected to be 4 percent next year, and the spot rate between the euro and dollar is $1.30, then according to interest rate parity, we would expect the dollar to _________ against the euro from $1.30 to __________:

Question

Quizplus · Accepted Answer

According to interest rate parity, the currency with the higher interest rate is expected to depreciate relative to the currency with the lower interest rate. In this scenario, the U.S. interest rate is higher than the European interest rate, thus the dollar is expected to depreciate against the euro. Furthermore, the formula for interest rate parity is:
Forward exchange rate = Spot exchange rate x (1 + Domestic interest rate) / (1 + Foreign interest rate)
Using this formula, we get:
Forward exchange rate = 1.30 x (1 + 0.06) / (1 + 0.04) = 1.325
Therefore, the dollar is expected to depreciate against the euro from $1.30 to $1.325.

If USInterest Rates Are Expected to Be 6 Percent Next Year