Question

Holding no other variables constant, which of the following statements is correct?
Select one:

A) an increase in the US market interest rate causes an appreciation of the euro
B) an increase in the interest rate of the US market causes a depreciation of the dollar
C) an increase in the interest rate of the US market causes an appreciation of the dollar
D) an increase in the US market interest rate does not affect the value of the dollar

Answer 1

Answer: (C)

When the federal reserve of US increases the interest rates, interest rates increase in the whole economy. US dollar interest rate products and bonds start to give higher rate of returns to the investors. Higher the interest rates, higher the yield. Hence, this higher yield attracts foreign investors, who sell their investments in local currency, and buy US dollar interest rate products and bonds looking for higher returns. This results in higher exchange rate for US dollars and US dollar value appreciates. Hence, an increase in the interest rate of the US market causes appreciation of the dollar.