Answer: domestic risk-free interest rate.

The correct answer is **C** because the arbitrage relationship between spot and forward exchange rates and interest rates can be expressed as: $$F_{id} = S_{id} \times \left(\frac{1 + i_d}{1 + i_f}\right)$$ where: - $F_{id}$ is the forward exchange rate, - $S_{id}$ is the spot exchange rate, - $i_d$ is the domestic risk-free interest rate, - $i_f$ is the foreign risk-free interest rate. An increase in the domestic risk-free interest rate ($i_d$) will lead to a decrease in the forward exchange rate ($F_{id}$), as the denominator in the equation grows larger relative to the numerator. This aligns with the arbitrage-free condition in efficient markets.

Author: LeetQuiz Editorial Team