Textbook Problem

Interest Rate Parity Application to Short-Term Financing Assume that the U.S. interest rate is 7 percent and the euro’s interest rate is 4 percent. Assume that the euro’s forward rate has a premium of 4 percent. Determine whether the following statement is true: "If interest rate parity does not hold, U.S. firms could lock in a lower financing cost by borrowing euros and purchasing euros for ward for one year." Explain your answer.