Assume that interest rate parity holds so that future or forward exchange rates
ID: 2725881 • Letter: A
Question
Assume that interest rate parity holds so that future or forward exchange rates adjust to eliminate investor arbitrage profits. If interest rates in Britain are higher than corresponding interest rates in Japan, would you expect an appreciating pound or a depreciating pound in the futures (forward) market relative to the current spot market rate? In terms of the supply and demand for pounds in the spot and forward currency markets, what is implicitly occurring in each as a result of interest rate parity? Is the pound selling forward at a premium or at a discount relative to the yen?
Explanation / Answer
If interest rates in Britain are higher than corresponding interest rates in Japan, we expect apprecating pound based on interest rate parity
The supply and demand will ncrease because of this
it is selling at premium