Although IRP tends to hold, it may not hold precisely all the time:
A) due to transactions costs, like the bid ask spread. B) due to asymmetric information. C) due to capital controls imposed by governments. D) both a and c
The correct option is D) both a and c.
Interest Rate Parity (IRP) can be described as the arbitrage condition that must hold when equilibrium occurs in the in the international financial market.
Arbitrage refers to the purchase and sale of financial assets such as securities, currency, or commodities, simultaneously in different markets or in forms of derivative forms with the aim of making profit from the differences in the prices of the same asset.
In any market, IRP will always hold because that indicates equilibrium in the market.
However, IRP may fail to hold all the time due to transactions costs, like the bid ask spread, and also due to capital controls imposed by governments.
Whenever IRP does not hold, the exchange rates and interest rates would be brought back into line by the pressure from arbitrageurs.
Based on the explanation above, the correct option is D) both a and c.
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