Question

In a market with an unchanged current exchange rate where the interest parity condition​ holds, if investors now expect the exchange rate to be 6.00​% lower a year from​ now, the return on foreign bonds with an interest rate of 7.50​% would be _______%​(Enter your response rounded to two decimal​ places.)

Answer 1

Foreign bond will give interest of 7.50% + 6% = 13.50%

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Interest rate parity is a no-arbitrage condition representing an equilibrium state under which investors will be indifferent to interest rates available on bank deposits in two countries.

Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise.The opposite relationship exists for decreasing interest rates – that is, lower interest rates tend to decrease exchange rates.