Question #40
Reading: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value
PDF File: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value.pdf
Page: 16
Status: Unattempted
Correct Answer: A
Question
Professor Imada Suzaken made the following statement to his economics class: "If you can earn 8% on A-rated bonds in the U.S. but only 6% on similar bonds in Canada, Canadian investors may want to buy those bonds in the U.S. for the excess return. However, after collecting the extra dollars, the investors would lose those profits when they converted their gains into their home currency." Suzaken's statement most accurately describes:
Answer Choices:
A. covered interest rate parity
B. uncovered interest-rate parity
C. purchasing-power parity
Explanation
Uncovered interest-rate parity is the concept that exchange rates must change so that the
return on investments with identical risk will be the same in any currency. Suzaken's
statement reflects uncovered interest rate parity. Covered interest rate parity would be
applicable if the investor hedges the foreign exchange risk via a forward exchange rate
contract.