Question
__________ is a theory according to which the interest
rate differential between two countries is equal to the differential between the forward exchange rate and spot exchange rate.Solution
The interest rate parity (IRP) is a theory regarding the relationship between the spot exchange rate and the expected spot rate or forward exchange rate of two currencies, based on interest rates. The theory holds that the forward exchange rate should be equal to the spot currency exchange rate times the interest rate of the home country, divided by the interest rate of the foreign country.
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