It is clear that intercountry interest rate differentials are not exactly matched by appropriate forward discounts on the currencies of high interest rate countries. Nevertheless this does not provide a reason for rejecting the notion of interest rate parity.
True or False?
The answer is True. Interest rate parity says that the forward discount on the domestic currency will equal the excess of the domestic nominal interest rate over the foreign nominal interest rate plus an allowance for country-specific or political risk. Since we have no independent measure of this risk, we can never be sure that any difference between the interest rate differential and the forward discount is not due to it. It is correct to say that covered interest parity does not hold in the sense that the interest rate differential does not equal the forward discount, but incorrect to thereby conclude that the interest parity condition is false---to do so would be to argue that the risk premium, about which we have no direct evidence, is in fact zero