Question

According to the uncovered interest parity (UIP) theory, domestic currency appreciates when domestic monetary policy tightens because:

A) The higher domestic yield makes domestic currency more attractive in terms of expected return

B) The lower domestic yield makes domestic currency more attractive in terms of expected return

C) The appreciation in the domestic currency in the spot market increases the expected appreciation of the domestic currency

D) The appreciation in the domestic currency in the spot market decreases the expected appreciation of the domestic currency

E) None of the above

Answer 1

from the above, LHS is the domestic expected return & RHS denotes expected foreign return in domestic terms.

when monetary tightening => money supply reduces => domestic interest rate increases=> domestic expected return increases => currency appreciates => E decreases

Hence the correct option is A.