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Suppose the U.S. one-year interest rate is 3% per year, while a foreign country has a...

Suppose the U.S. one-year interest rate is 3% per year, while a foreign country has a one-year interest rate of 5% per year. Ignoring risk and transaction costs, a U.S. investor should invest in foreign bonds as long as the expected yearly rate of depreciation of the foreign currency is

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Answer #1

US one year interest rate is 3%

Foreign country one year interest rate is 5%.

Since the foreign country one year interest rate is higher than US one year interest rate, it induce US investor to invest in foreign country. As a result, the demand for foreign currecny will increase which leads to depreciation of foreign currency.

According to Interest Pariy Condition, the foreign currecncy will depreciates by 2% (i.e., 5% - 3%).

Therefore,  a U.S. investor should invest in foreign bonds as long as the expected yearly rate of depreciation of the foreign currency is less than 2%.

Answer: Less than 2%

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