Question

Select all that are true regarding covered interest rate parity (1):

A. Arbitrage drives global markets away from it T
B. territorial taxes that are approximately equal (proportionate) should not matter to it
C. It is limited by geopolitical risk since this risk requires a premium in retum
D.It is limited by differing transactions costs between foreign and domestic markets
E.It is limited by the additional costs of liquidating foreign holdings

Answer 1

Covered interest rate parity (CIRP) is a financial concept that asserts that the interest rate differential between two countries will be offset by the forward exchange rate between their currencies. Regarding the statements given, arbitrage drives global markets away from it, territorial taxes can influence it, geopolitical risk requires a premium in return, differing transaction costs between foreign and domestic markets limit it, and additional costs of liquidating foreign holdings also limit it.

Step-by-step explanation:

Covered interest rate parity (CIRP) is a financial concept that asserts that the interest rate differential between two countries will be offset by the forward exchange rate between their currencies. Regarding the statements given:

1. Arbitrage drives global markets away from it: This statement is true. Arbitrage opportunities in the foreign exchange market will be immediately exploited by investors, leading to an adjustment in interest rates and exchange rates.
2. Territorial taxes that are approximately equal should not matter to it: This statement is false. Territorial taxes can influence covered interest rate parity if they create disincentives for foreign investment or affect the relative attractiveness of two countries' financial markets.
3. It is limited by geopolitical risk since this risk requires a premium in return: This statement is true. Geopolitical risks, such as political instability or conflicts, can increase the risk premium demanded by investors and affect covered interest rate parity.
4. It is limited by differing transaction costs between foreign and domestic markets: This statement is true. Higher transaction costs in foreign markets can impede arbitrage and limit the efficiency of covered interest rate parity.
5. It is limited by the additional costs of liquidating foreign holdings: This statement is true. Liquidating foreign holdings can incur additional costs, such as fees or taxes, which can influence covered interest rate parity.