Question #38
Reading: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value
PDF File: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value.pdf
Page: 15
Status: Unattempted
Question
Ackerman explains to Bos that a theoretical relationship exists between forward rates and future spot rates, called the forward rate parity. This relation suggests that:
Answer Choices:
A. the forward rate is an unbiased predictor of the expected future spot rate, and uncovered interest rate parity would hold
B. the forward rate is a biased predictor of the expected future spot rate, and uncovered interest rate parity would not hold
C. the forward rate is an unbiased predictor of the expected future spot rate, and uncovered interest rate parity would not hold
Explanation
The forward rate parity is F = E(S1), meaning that the forward rate is an unbiased predictor
of the expected future spot rate. If this is the case, uncovered interest rate parity would be
same as covered interest rate parity and since covered interest rate parity holds (by
arbitrage), uncovered interest rate parity would also hold.