Question

Suppose interest rate parity holds, and the current risk-free rate in the United States is 2.1 percent per six months. What must the six-month risk-free rate be in Australia? In Japan? In Great Britain?

Answer 1

If interest rate parity holds and the risk-free rate in the United States is 2.1% per six months, the risk-free rates in Australia, Japan, and Great Britain would also be 2.1% per six months.

Step-by-step explanation:

Interest rate parity states that the difference in interest rates between two countries is equal to the difference in their exchange rates. In this case, if the current risk-free rate in the United States is 2.1% per six months, we can use interest rate parity to calculate the risk-free rates in Australia, Japan, and Great Britain.

Let's say the current exchange rate is 1 US dollar = 1 Australian dollar. If the risk-free rate in the United States is 2.1% per six months, then the risk-free rate in Australia must be the same for interest rate parity to hold. Therefore, the risk-free rate in Australia would also be 2.1% per six months.

Similarly, if the current exchange rate is 1 US dollar = 100 Japanese yen, and the risk-free rate in the United States is 2.1% per six months, then the risk-free rate in Japan must be the same for interest rate parity to hold. Therefore, the risk-free rate in Japan would also be 2.1% per six months.

Finally, if the current exchange rate is 1 US dollar = 0.8 British pounds, and the risk-free rate in the United States is 2.1% per six months, then the risk-free rate in Great Britain must be the same for interest rate parity to hold. Therefore, the risk-free rate in Great Britain would also be 2.1% per six months.