Assuming covered interest parity holds, a(n)________ in the domestic interest rate will ________ the forward rate, all other things held constant.

Question

Quizplus · Accepted Answer

According to covered interest parity, the forward exchange rate should reflect the interest rate differential between two currencies. If the domestic interest rate increases, the country's currency becomes more attractive to foreign investors, leading to an increase in demand for the currency and an increase in its value. This causes the forward exchange rate to decrease since the foreign currency will be cheaper in the future compared to the current rate. Therefore, an increase in the domestic interest rate will decrease the forward rate, all other things held constant.

Assuming Covered Interest Parity Holds, A(n)________ in the Domestic Interest