If rF and rD are the interest rates of a foreign country and domestic country, respectively, and if SF/D and fF/D are spot exchange rate and forward exchange rate between the countries F and D, the interest rate parity is indicated by :
\( \dfrac{(1 + r_F)}{(1 + r_D)} = \dfrac{f_{F/D}}{S_{F/D}} \)
Option 3 is correct: \( \dfrac{(1 + r_F)}{(1 + r_D)} = \dfrac{f_{F/D}}{S_{F/D}} \).
Interest Rate Parity (IRP) is a no-arbitrage condition connecting interest rates in two countries with their spot and forward exchange rates. It says an investor should earn the same hedged return whether funds are invested at home or abroad; otherwise covered-interest arbitrage would eliminate the difference.
With the quote written as units of F per unit of D, investing at the foreign rate grows funds by \( (1 + r_F) \) while investing domestically grows them by \( (1 + r_D) \). To compare, the foreign proceeds must be converted back through the forward rate, giving the parity relation:
\( \dfrac{1 + r_F}{1 + r_D} = \dfrac{f_{F/D}}{S_{F/D}} \)
Thus the country with the higher interest rate trades at a forward discount, and the currency with the lower rate trades at a forward premium — exactly cancelling the interest advantage.
Why the others are wrong: Option 1 inverts the interest-rate ratio; Option 2 pairs the correct interest ratio with an inverted (S/f) exchange ratio; Option 4 is ruled out because Option 3 is a valid form of IRP.
Takeaway: Interest ratio (F over D) equals the forward-to-spot ratio — the essence of covered interest parity.
Similar Questions
Which one of the following transactions can be carried on without any restriction or regulation of the RBI under the FEMA?
Which of the following is true :
Foreign exchange quotation when expressed in a manner that reflects the exchange of a specified number of foreign currencies vis-à-vis one unit of local currency is expressed as :
According to which of the following theories of International Business, the pattern of FDI is determined by combination of Core Competency, locational advantage and entry mode ?
‘Human Capacity’ under Building Trade Capacity as per efforts made by WTO to meet special requirements of developing countries refers to help on which of the following :
‘Horizontal FDI’ means :
Given below are two statements : one is labelled as Assertion (A) and the other is labelled as Reason (R).
Assertion (A) : For exports of goods, the exporter has to apply to the nominated export inspection agency for conducting the pre-shipment and quality control inspection for the export consignment and obtain Export Credit Certificate conforming to the prescribed specifications.
Reason (R) : This inspection certificate would be required for customs clearance of cargo before shipment.
In the light of the above statements, choose the most appropriate answer from the options given below :
Match List - I with List - II.
List - I
(Organizations)List - II
(Management tools and Techniques)A. World Bank I. Trade Policy Review Mechanism (TPRM) B. WTO II. International Commodity Agreements (ICAs) C. CFC III. Global System of Trade Preferences (GSTP) D. UNCTAD IV. The Logistics Performance Index (LPI) Choose the correct answer from the options given below :
A conscious belief that only the host-country managers can ever really understand the culture and behaviour of the host-country market. It refers to which of the following top executives’ values :
An Indian company is importing machine at a price of $ 5,00,000, payable after six months. The current exchange rate is ₹ 63 per US $. The forward contract for six months is available @ ₹ 64 per US $. If the rate turns out to be ₹ 64.25 per US $, the net gain to the importer in case he has entered into contract will be :
Important Questions from International Business
- Which is not one of the three dimensions of IHRM according to Peter J Dowling and Denice E Welch?
- Which are the four cultural predispositions of MNCs?
- Which among the following pertain to international staffing policy?
A. Geocentric
B. Expatriates
C. Repatriates
D. Employee leasing
E. Career portability
Choose the correct answer from the options given below: - Fill in the blank
"The member countries of WTO have moved to product patent regime under the __________ to meet their obligations under the seven areas covered by the __________ agreement". - Match the List-I and List-ll regarding International business theories with developers:
List I List II (i) Absolute Cost Advantage theory (a) Raymond Xernon (ii) Comparative Cost Advantage theory (b) Adam Smith (iii) Factor Endowment theory (c) David Recardo (iv) Product Life cycle theory (d) Eli Heckscher
