There are two neighbouring countries; Ankland and Barnam. Currently, their currencies are trading at par. The risk-free rate in Ankland is 4% and the risk-free rate in Barnam is 6%. According to interest rate partiy, the analyst would expect that…
a. Ankland’s currency will depreciate and Barnam’s currentcy will trade at a premium in the forward market.
b. Ankland’s currency will appreciate and Barnam’s currency will trade at a premium in the forward market.
c. Ankland’s currency will appreciate and Barnam’s currency will trade at a discount in the forward market.
The answer is apparently C. However, I chose A because if the interest rate in Barnam is 6%, surely investors are going to invest at the higher rate of 6% and this will appreciate the currency?