Discuss the interest rate parity, Financial Accounting

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Below is information about the spot and forward rates for three currencies against the US dollar (USD):

Currency (exchange rate) Spot Rate Six-month forward rate

Euro (EUR)                                                      (EUR/USD)                                                0.84 0.81

Japanese Yen (JPY)                                         (JPY/USD)                                                 122.10 118.80

British Pound (GBP)                                         (USD/GBP)                                                1.47 1.49

(a) Critically discuss the interest rate parity and covered interest arbitrage theories.

(b) Discuss the conditions for interest rate parity theory to hold.

(c) Use the spot exchange rates to check if interest rate parity holds or not, given the following sixmonth interest rates:

United States          5.60 per cent

Euro area                3.40 per cent

Japan                    1.00 per cent

Britain                   5.25 per cent

 


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