Question

If interest rate on dollar deposits is 2% and on Yen deposits is 5% does it tell you anything about exchange rate between dollar and yen. Explain your answer in 8 sentences. No more no less.

Don't go on and on talking about irrelevant facts. Stick to the question.

Answer 1

The exchange rate between two currencies depend on a number of factors. Interest rate differentials of the currencies is an important factor determining the exchange rate. The currency with the higher interest rate provides a higher earning potential to the investors. Therefore, the currency with the higher interest rate faces a higher demand. On the other hand, the currency with the lower interest rate faces lower demand. In the floating exchange rate system, the currency relative demand of the currencies affect the exchange rate. So, the currency with higher interest rate would experience appreciation with respect to the other currency. So, Yen would experience an appreciation over dollar.