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Assume that interest rate parity holds, and the euro's interest rate is 9 percent while the U.S. interest rate is 12 percent. Then the euro's interest rate increases to 11 percent while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity.

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Answer:

As a result of the increase in the interest rate on euros, the euro's forward PREMIUM will DECREASE in order to maintain interest rate parity.

Explanation:

The forward exchange rate is the currency exchange rate at which a bank or other financial institution agrees to exchange one currency for another in a specific future date. The forward premium represents a situation where the forward exchange rate is higher than the actual exchange rate.

In this case, since the euro's interest rate will increase by 2%, then its premium will decrease (future expected value will also decrease) so that the interest rate parity remains stable.

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