Author Question: There are several reasons why interest rate parity may not hold exactly and, therefore, we can earn ... (Read 176 times)

jon_i · **on:** Jun 30, 2018

There are several reasons why interest rate parity may not hold exactly and, therefore, we can earn arbitrage profits from this situation.

Indicate whether the statement is true or false

Question 2

A permanent increase in the domestic money supply

A) must ultimately lead to a proportional decrease in E, and, therefore, the expected future exchange rate must rise proportionally.
B) must ultimately lead to a proportional decrease in E, and, therefore, the expected future exchange rate must decrease proportionally.
C) must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise proportionally.
D) must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise more than proportionally.
E) must ultimately lead to a proportional rise in E, and, therefore, the expected future exchange rate must rise less than proportionally.

Meganchabluk · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

FALSE
Explanation: Transaction costs, differential taxation, government controls, political risk, and time lags between observing a profit opportunity and actually trading to realize the profit are the reasons that we can not earn arbitrage profits on a permanent basis.

Answer to Question 2

C