2. Answer the following questions: a. What is the interest parity condition? Include the appropriate equation...
2. Answer the following questions:
a. What is the interest parity condition? Include the appropriate equation and explain.
b. Is “arbitrage” possible when the interest rate parity condition holds? Define “arbitrage” and explain.
c. What do we mean by “exchange rate overshooting”? Why does it happen?
Homework Answers
ANSWER 1:-
INTEREST PARITY RATE - It is a theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate.
The Formula For Interest Rate Parity (IRP) Is
F0=S0×(1+1b1+ic)
where:F0=Forward Rate
S0=Spot Rate
ic=Interest rate in country c
ib=Interest rate in country b
ANSWER 2:-
The interest rate parity presents an idea that there is no arbitrage in the foreign exchange markets.
Arbitrage is defined as the simultaneous purchase and sale of an asset to profit from an inequality in the price from different platform.
ANSWER 3:-
The term overshooting defined as the irrational fluctuation of the nominal exchange rate in response to a change in the monetary supply. In other words an excess of the exchange rate’s short run response to a change in market fundamentals over its long run response .
Add Answer to:
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