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Answer: Covered interest rate parity holds, among other reasons, because the amount of currency that will be obtained from investing in either the domestic or the foreign currency is certain.
A is correct. Covered interest rate parity holds because there is no uncertainty as to the amount of currency that will be obtained from investing in either the domestic or the foreign currency.
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A financial institution's risk manager is training a newly hired team of analysts on the fundamental concepts and principles of foreign exchange rate parity, which play a crucial role in understanding currency markets and international finance. During the session, the manager explains the key assumptions, mathematical formulas, and implications associated with two primary theories: covered interest rate parity (CIRP) and uncovered interest rate parity (UIP). Considering this context, identify the correct statement regarding these two theories from the options provided below:
A
Covered interest rate parity holds, among other reasons, because the amount of currency that will be obtained from investing in either the domestic or the foreign currency is certain.
B
Uncovered interest rate parity is a no-arbitrage theorem that incorporates each country's inflation rate into the covered interest rate parity formula to predict future exchange rates.
C
Forward rates are found using the covered interest rate parity theorem by multiplying the spot rate by the ratio of 1 plus the risk-free interest rate in the base currency to 1 plus the risk-free interest rate in the quote currency raised to the time to maturity.
D
Forward points, when expressed as a percentage of the spot rate, can be used to determine the interest rate and inflation differential in uncovered interest rate parity.