The risk premium included in the interest rate of small open economies incorporates:
A) country risk and expectations of future exchange-rate changes.
B) the law of one price.
C) inefficient activity by arbitrageurs.
D) capital mobility.

Question

Quizplus · Accepted Answer

The risk premium included in the interest rate of small open economies incorporates country risk, which refers to the likelihood of political or economic instability, and expectations of future exchange-rate changes, which may affect the returns earned by foreign investors. This risk premium compensates investors for the additional risk they take on when investing in a country with a higher perceived risk of default or currency depreciation. The other choices, such as the law of one price, inefficient activity by arbitrageurs, and capital mobility, are not directly related to the risk premium in interest rates of small open economies.

The Risk Premium Included in the Interest Rate of Small