If the forward rate was expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then:
A) covered interest arbitrage is feasible.
B) the international Fisher effect (IFE) is supported.
C) the international Fisher effect (IFE) is refuted.
D) the average absolute error from forecasting would equal zero.

Question

Quizplus · Accepted Answer

If the forward rate was expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then the international Fisher effect (IFE) is supported. The IFE states that the difference in interest rates between two countries will be equal to the difference in their inflation rates. Therefore, if interest rate parity holds and the forward rate is an unbiased estimate of the future spot rate, then the IFE must also hold. Covered interest arbitrage may or may not be feasible depending on the specific interest rates and foreign exchange rates involved, and the average absolute error from forecasting may or may not equal zero depending on the accuracy of the forecasting method used.

If the Forward Rate Was Expected to Be an Unbiased