When Interest Rate Parity (IRP)does not hold
A)there is usually a high degree of inflation in at least one country.
B)the financial markets are in equilibrium.
C)there are opportunities for covered interest arbitrage.
D)the financial markets are in equilibrium and there are opportunities for covered interest arbitrage.

Question

Quizplus · Accepted Answer

When Interest Rate Parity (IRP) does not hold, there are opportunities for covered interest arbitrage. This means that an investor can borrow funds in a currency with a low interest rate, convert them into a currency with a higher interest rate, invest them in the higher interest rate country, and then convert the investment back into the low interest rate currency when the investment matures. This arbitrage opportunity would not exist if IRP were holding true. The other options, A and B, are not correct as high inflation is not always a factor in IRP not holding true and financial market equilibrium does not necessarily indicate whether IRP is holding true or not.

When Interest Rate Parity (IRP)does Not Hold