Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.
A) forward realignment arbitrage
B) triangular arbitrage
C) covered interest arbitrage
D) locational arbitrage

Question

Quizplus · Accepted Answer

Covered interest arbitrage is the process of taking advantage of the interest rate differential of two currencies by borrowing in a low-interest-rate currency and investing in a high-interest-rate currency. This should result in a forward premium on the high-interest-rate currency relative to the low-interest-rate currency to compensate for the interest rate differential. If the forward premium is lower than expected, market forces should work to realign it with the interest rate differential through increased demand for the high-interest-rate currency, which should drive up its value and increase the forward premium. Conversely, if the forward premium is higher than expected, market forces should drive down its value and decrease the forward premium to make it more in line with the interest rate differential.

Due to ____, Market Forces Should Realign the Relationship Between