Assume that the U.S. interest rate is 11 percent, while Australia's one-year interest rate is 12 percent. Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to forecast the future spot rate, the forecast would reflect an expectation of:
A) depreciation in the Australian dollar's value over the next year.
B) appreciation in the Australian dollar's value over the next year.
C) no change in the Australian dollar's value over the next year.
D) information on future interest rates is needed to answer this question.

Question

Quizplus · Accepted Answer

According to interest rate parity, the difference in interest rates between two countries should equal the expected change in their exchange rate. Since Australia's interest rate is higher than the US, the expected change in the exchange rate should be in favor of the US dollar. Therefore, the Australian dollar is expected to depreciate against the US dollar over the next year.

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