Answer: Covered interest rate parity

## Explanation Among the three international parity conditions: - **Covered Interest Rate Parity (CIRP)** is enforced by arbitrage - **Forward Rate Parity** and **Purchasing Power Parity (PPP)** are not enforced by arbitrage **Why CIRP is enforced by arbitrage:** - CIRP states that the forward exchange rate should equal the spot exchange rate adjusted for the interest rate differential between two countries - If this relationship doesn't hold, arbitrageurs can execute covered interest arbitrage: - Borrow in the low-interest currency - Convert to the high-interest currency at spot rate - Invest in the high-interest currency - Lock in the forward rate to eliminate exchange rate risk - Earn risk-free profits - This arbitrage activity quickly eliminates any deviations from CIRP **Why PPP is not enforced by arbitrage:** - PPP suggests that exchange rates should adjust to equalize purchasing power across countries - However, arbitrage is difficult due to: - Transaction costs - Non-tradable goods - Trade barriers - Different consumption baskets **Why Forward Rate Parity is not enforced by arbitrage:** - Forward rate parity is essentially the same as CIRP, so it is enforced by arbitrage - However, among the options given, Covered Interest Rate Parity is the most direct answer Therefore, **Covered Interest Rate Parity (Option C)** is the international parity condition that is enforced by arbitrage.

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