1. It is often said that interest rate parity is satisfied when the differential between the interest rates denominated in two currencies equals the forward premium or discount between the two currencies. Explain why this is an imprecise statement when the interest rates are not continuously compounded.
2. What do economists mean by the external currency market?
3. What determines the bid-ask spread in the external currency market? Why is it usually so small?
4. Explain why the absence of covered interest arbitrage possibilities can be characterized by two inequalities in the presence of bid-ask spreads in the foreign exchange and external currency markets.