Question

If interest rate parity does not hold __________.

Multiple Choice:
O covered interest arbitrage opportunities will not exist.
O arbitragers will be able to make risk-free profits.
O covered interest arbitrage opportunities will not exist, and arbitragers will be able to make risk-free profits.
O covered interest arbitrage opportunities will exist.
O covered interest arbitrage opportunities will exist, and arbitragers will be able to make risk-free profits.

Answer 1

covered interest arbitrage opportunities will exist, and arbitragers will be able to make risk-free profits.

Step-by-step explanation:

Interest rate parity (IRP) is a theory which suggests that the rates of return on comparable assets in two different countries are equal, meaning it is a no-arbitrage condition where investors are at a equilibrium state by being less-concerned about the interest rates by banks in two different countries.

Basically, Interest rate parity gives the relationship between spot exchange, interest and foreign exchange rates.

If interest rate parity does not hold, covered interest arbitrage opportunities will exist, and arbitragers will be able to make risk-free profits.

However, if interest rate parity holds, covered interest arbitrage opportunities will not exist.