4. Interest rate parity

The rise of globalization is due to the many companies that have become multinational corporations for various reasonsfor example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence exposes companies to different kinds of risk as wellfor example, political risk and exchange rate risk.

The relationship between interest rates and exchange rates can be represented through the concept of interest rate parity. Consider the following:

An American investor is considering investing $1,000 in default-free 90-day Japanese bonds that promise a 3% annual nominal return.

	The spot exchange rate is 101.12 per dollar.
	The 90-day forward exchange rate is 100.25 per dollar.

The investors annualized return on these bondsif he or she can lock in the dollar return by selling the foreign currency in the forward marketwill be ? .

Which of the following statements is implied by interest rate parity theory?

Interest rates in all countries with the same political risk should be the same.

Interest rates in all countries should be the same.

An investment in ones home country should have the same return as a similar investment in a foreign country.

A product bought in one country should have the same price in other countries, adjusted for exchange rate.