Question

Settings According to the interest parity​ condition, if the domestic interest rate is 10 percent and the foreign interest rate is 12​ percent, then the expected​ ________ of the foreign currency must be​ ________ percent.

Answer 1

depreciation , 2 percent

Step-by-step explanation:

As per interest rate parity theory, the investment opportunities in two different countries will always be the same and there is no possibility of earning arbitrage gains as there will be no mispricing.

A country's currency and interest rate are inversely related.

The currency whose interest rate is lower, would be at a forward premium while the currency whose interest rate is higher, would be at a forward discount.

In the given case, since the interest rate of foreign currency exceeds interest rate of home currency by 2%, the expected depreciation of the foreign currency will be equal to this difference i.e 2%.