Under the extended balance portfolio model of exchange rate determination, predict what will be the effect of Zambia’s exchange rate if the domestic interest rate was to fall relative to the foreign interest rate.
Exchange rate is the rate at which two currencies are exchanged for each other, it is the price of one currency in terms of another currency.
'Portfolio Balance model of exchange rate determination' states that : demand & supply of domestic & foreign currencies, for transactionary and also investment assets holdings purposes - determines the exchange rate.
The model is based on assumption that people hold on risk free asset (domestic currency), risky assets with return (domestic investment assets or foreign investment assets). So, these all are important factors affecting exchange rate determination as per the model.
If a country's [Zambia here] interest rate falls relative to foreign interest rate : It's currency's (Zambian Kwacha) demand decreases in the forex markets, due to reduction in its demand for its investment assets ie capital outflows, as it gives lower interest rate than foreign interest rate. So, decrease in demand of currency (Zambian Kwacha) leads to depreciation of the economy's currency (Zambian economy Kwacha) foreign exchange rate.
Get Answers For Free
Most questions answered within 1 hours.