ACCA Financial Management (F9) Certification Practice Exam

What does the four-way equivalence theorem explain regarding financial rates?

1. The equality of interest rates

2. The equality of inflation rates

3. The relationship between forward and spot rates

4. All of the above

The correct answer is: All of the above

The four-way equivalence theorem provides a comprehensive understanding of how various financial rates are interconnected, which is why the answer encompasses all aspects mentioned. This theorem highlights the equality of interest rates across different maturities, demonstrating that the effective yield on investments remains consistent when adjusted for time periods and risk. Furthermore, it addresses the equality of inflation rates by recognizing that inflation expectations can influence interest rates, impacting the overall yields on assets. The theorem also elucidates the relationship between forward and spot rates, indicating that the future costs and returns of investments can be rationalized through current spot rates adjusted by the interest rates of the respective currencies involved. By integrating these concepts, the four-way equivalence theorem effectively illustrates how interest rates, inflation expectations, and currency exchange rates interplay in financial markets, thereby establishing the broad connections between these essential financial constructs.