Question

Assume that the interest rate in the home country of Currency X is a much higher interest rate than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X:a. should exhibit a discount.

b. should exhibit a premium.
c. should be zero (i.e., it should equal its spot rate).

Answer 1

According to interest rate parity, the forward rate of Currency X should exhibit a discount

Step-by-step explanation:

Interest rate parity is when the difference between interest rates between two countries is equal to the difference in the spot and forward exchange rates.

Considering country X with currency X.

If currency X has an higher interest rate than US, currency X is expected to exhibit a discount (i.e. a rate used for discounting bills of exchange) in order to balance up with the exchange rate of US by realigning the relationship between the interest rate differential of X and the forward premium (or discount) on the forward exchange rate between the X and USD.

interest rate parity assumes that any currency with lower interest rate will trade at a forward premium compared to a currency with higher interest rate

Answer 2

A – forward rate of currency X should exhibit a discount

Step-by-step explanation:

the interest rate parity states that the interest rate differential between 2 countries is equal to the differential between the forward exchange rate and the spot exchange rate (Hayes, 2019). The theory assumes that a currency with lower interest rates will trade at a forward premium in relation to a currency with a higher interest rate (Hayes, 2019). The opposite is true for Currency X and the US Dollar – since currency X is higher than the US interest rate, its forward rate will be a discount. This makes A the correct answer.