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The theory of ________ states that the difference in the national interest rates for securities of...

The theory of ________ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs.
Select one:
a. relative PPP
b. interest rate parity
c. the law of one price
d. absolute PPP
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Answer #1

Answer: interest rate parity

According to this theory," interest rate differential between two countries should be equal to its differential of forward and spot exchanges" .Forward exchange rate is future exchange rate whereas spot exchange is the current exchange rate. When the difference between forward exchange rate and spot exchange rate is positive, it is known as forward premium and when it is negative, it is known as forward discount.

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