Question

The difference between the Covered Interest Parity (CIP) and the Uncovered Interest Parity

(UIP) is:
A) UIP involves only the immediate exchange of currency while CIP deals only with future exchange of
currencies.
B) CIP involves only the immediate exchange of currency while UlP deals only with future exchange of
currencies.
C) UIP hedges against exchange rate risk while CIP docs not.
D) CIP hedges against exchange rate risk while UIP docs not.

Answer 1

The correct difference between Covered Interest Parity (CIP) and Uncovered Interest Parity (UIP) is that CIP hedges against exchange rate risk while UIP does not (option C).

Step-by-step explanation:

The correct difference between Covered Interest Parity (CIP) and Uncovered Interest Parity (UIP) is that C) CIP hedges against exchange rate risk while UIP does not.

Covered Interest Parity (CIP) is an economic principle that states that the difference in interest rates between two countries should be equal to the difference in their forward exchange rates. It ensures that investors can earn the same return regardless of whether they invest domestically or internationally once exchange rate risk is taken into account.

On the other hand, Uncovered Interest Parity (UIP) suggests that investors can earn higher returns by investing in a foreign country with higher interest rates due to the expectation that the foreign currency will appreciate against their domestic currency. However, UIP does not consider exchange rate risk and does not provide a hedge against it.