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12. Explain. why., in. order. to preserve. the interest. rate. parity. (IRP), a country. with a...

12. Explain. why., in. order. to preserve. the interest. rate. parity. (IRP), a country. with a higher nominal interest rate should have its currency's forward exchange rate reflect expected depreciation against currencies of countries with lower interest rates.

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According to interest. rate. parity the currency of a country with higher interest rate should appreciate against country with lower interest rate. Sometime a higher nominal interest rate should have its currency's forward exchange rate reflect expected depreciation against currencies of countries with lower interest rates.

This is because currency exchange rate does not only depend on interest rate, it also depends on inflation rate in countries and demand and supply of currency. if interest rate is higher but inflation rate is also higher and demand of such currency is lower in market then its currency must be depreciating even with higher interest rate.

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