Assume that interest rate parity holds. The U.S. one-year interest rate is 10% and the Australian one-year interest rate is 8%. What will the approximate effective yield be for an Australian citizen of a one-year deposit denominated in U.S. dollars? Assume the deposit is covered by a forward sale of dollars.

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According to interest rate parity, the forward exchange rate should adjust to compensate for the difference in interest rates between two countries. Therefore, the Australian investor can expect to earn the same rate of return on a one-year investment in U.S. dollars as they would on a one-year investment in Australian dollars. Since the Australian one-year interest rate is 8%, the approximate effective yield for the Australian investor on a one-year deposit denominated in U.S. dollars would also be 8%.

Assume That Interest Rate Parity Holds