Question

Suppose the New Zealand interest rate is equal to 8% per year and the U.S. interest rate is equal to 10% per year. For the interest rate parity condition to hold it must be the case that

a. The NZD sells at a 3-month forward discount of about .005 relative to the USD.
b. The NZD sells at a 3-month forward premium of about .005 relative to the USD.
c. The NZD sells at a 3-month forward discount of about .018 relative to the USD.
d. The NZD sells at a 3-month forward premium of about .018 relative to the USD.

Answer 1

To satisfy interest rate parity, the New Zealand dollar (NZD) must trade at a forward discount relative to the U.S. dollar (USD) due to the higher U.S. interest rate; an exact discount value cannot be determined without specific exchange rate figures.

Step-by-step explanation:

For the interest rate parity condition to hold between New Zealand and the U.S., it must be the case that the currency of the country with the higher interest rate (U.S.) appreciates relative to the other. Since the U.S. interest rate is 10% compared to New Zealand's 8%, the New Zealand dollar (NZD) should trade at a forward discount relative to the U.S. dollar (USD). However, without specific exchange rate numbers, we cannot exactly calculate the forward discount. Therefore, we can only provide a qualitative answer that supports a forward discount for NZD without an exact value.